[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
INCREASING DISCLOSURE TO BENEFIT INVESTORS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
FINANCE AND HAZARDOUS MATERIALS
of the
COMMITTEE ON COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
on
H.R. 887 and H.R. 1089
__________
OCTOBER 29, 1999
__________
Serial No. 106-70
__________
Printed for the use of the Committee on Commerce
U.S. GOVERNMENT PRINTING OFFICE
61-039 CC WASHINGTON : 1999
COMMITTEE ON COMMERCE
TOM BLILEY, Virginia, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas RALPH M. HALL, Texas
FRED UPTON, Michigan RICK BOUCHER, Virginia
CLIFF STEARNS, Florida EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio FRANK PALLONE, Jr., New Jersey
Vice Chairman SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania BART GORDON, Tennessee
CHRISTOPHER COX, California PETER DEUTSCH, Florida
NATHAN DEAL, Georgia BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma ANNA G. ESHOO, California
RICHARD BURR, North Carolina RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California BART STUPAK, Michigan
ED WHITFIELD, Kentucky ELIOT L. ENGEL, New York
GREG GANSKE, Iowa THOMAS C. SAWYER, Ohio
CHARLIE NORWOOD, Georgia ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma GENE GREEN, Texas
RICK LAZIO, New York KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming TED STRICKLAND, Ohio
JAMES E. ROGAN, California DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING,
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland
James E. Derderian, Chief of Staff
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Finance and Hazardous Materials
MICHAEL G. OXLEY, Ohio, Chairman
W.J. ``BILLY'' TAUZIN, Louisiana EDOLPHUS TOWNS, New York
Vice Chairman PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania ELIOT L. ENGEL, New York
CHRISTOPHER COX, California DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California BILL LUTHER, Minnesota
GREG GANSKE, Iowa LOIS CAPPS, California
RICK LAZIO, New York EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois RALPH M. HALL, Texas
HEATHER WILSON, New Mexico FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Dickson, Joel M., Senior Investment Analyst, Vanguard Group.. 17
Fink, Matthew P., President, Investment Company Institute.... 29
Jones, David B., Vice President, FMR Co...................... 22
Mason, James L., Director of Public and Community Affairs,
Eaton Corporation.......................................... 8
Thompson, Robert B., George Alexander Madill Professor of
Law, Washington University................................. 4
Material submitted for the record by:
American Society of Corporate Secretaries, letter dated
October 27, 1999, to Hon. Tom Bliley and Hon. Michael G.
Oxley...................................................... 98
Association of Publicly Traded Companies, letter dated
October 28, 1999, to Hon. Tom Bliley and Hon. Michael G.
Oxley...................................................... 41
Business Roundtable, The, letter dated July 23, 1999......... 42
Dingell, Hon. John D., a Representative in Congress from the
State of Michigan, prepared statement with attachments..... 50
OMB Watch, letter dated November 3, 1999, to Hon. Michael G.
Oxley...................................................... 48
Ridings, Dorothy S., President and CEO, Council on
Foundations, prepared statement of......................... 44
Securities and Exchange Commission, prepared statement of.... 46
(iii)
INCREASING DISCLOSURE TO BENEFIT INVESTORS
----------
FRIDAY, OCTOBER 29, 1999
House of Representatives,
Committee on Commerce,
Subcommittee on Finance and Hazardous Materials,
Washington, DC.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2123, Rayburn House Office Building, Hon. Paul E. Gillmor
presiding.
Members present: Representatives Gillmor, Markey, and Cox.
Staff present: Brent DelMonte, majority counsel; David
Cavicke, majority counsel; Brian McCullough, majority
professional staff; Robert Simison, legislative clerk; and
Consuela Washington, minority counsel.
Mr. Gillmor. The committee will come to order and we will
proceed with the first bill. We have two bills up today and two
panels, and we will do opening statements on the first bill,
and then do the panel and then the same procedure on the second
bill.
I might tell those that are here that attendance is a
little weak today because Congress is not in session. We were
scheduled to be recessed, and when that happens, members leave
town.
I want to thank members on both panels for coming. I know
that a number of you have come from some distance and we very
much appreciate your lending us your time and your expertise.
The first bill is H.R. 887, improved disclosure of
charitable contributions by corporations, and I want to thank
both Chairman Mike Oxley and ranking member Ed Towns who have
cosponsored this legislation which I have introduced.
Over 60 years ago, we determined as part of national policy
that shareholders are entitled to receive relevant information
from corporate management. Corporations give more than $8.5
billion per year in charity, and there is no reason why
shareholders should be denied knowledge of that information.
Under current law if a corporation donates money to a
charitable organization, the corporation is under no obligation
to reveal anything about those gifts. Because those gifts are
donated from shareholder earnings, a reasonable disclosure
requirement is a matter of accountability. Now some
corporations voluntarily disclose this type of information,
including Eaton Corporation which is testifying today, and I
want to commend those who voluntarily do disclose.
This is not an issue about which groups receive charitable
contributions from corporations, it is an issue of shareholder
rights. Shareholders are the owners of a company's assets, and
nothing in my legislation questions a company's commitment to
social responsibility. Likewise, nothing in the legislation
prohibits or restricts management's right to make donations or
assess to whom or how much. I simply believe that shareholders
have a right to review management's decisions and rationale.
I have heard all of the arguments from companies and
charities that feel threatened by this legislation. It is too
costly, too burdensome. Shareholders are not interested. The
amount of contributions is insignificant, given out to local
companies, and more.
Of the Fortune 100 companies which have provided SEC
information about charitable giving, 53 percent of the number
of cash contributions were $2,500 or less. A threshold of just
$2,500 would require those companies to report less than half
their contributions, and I would imagine that smaller companies
would have to report less than that. Contributions of $2,500 or
less, however, accounted for less than 4 percent of the total
dollar amount. Less than 2 percent of the contributions exceed
$100,000, but those contributions represent 46 percent of the
total amount contributed.
We are not talking about disclosing checks to the local
boys' and girls' clubs, we are talking about significant
contributions from shareholder earnings, and I have spent a lot
of time working with both business and charity groups to find a
workable disclosure requirement.
The subcommittee did extend an invitation to the Business
Roundtable to be with us today. I regret that they and a member
company were not able to be here today, but we have met with
them in the past and their views are certainly welcome at any
time in the future as well.
The fact is companies that do voluntarily disclose their
giving haven't had those problems. Arguments raised from
companies against the bill come mostly from managers who don't
want to tell shareholders where they are giving the money away
and use those arguments as excuses. If a CEO's spouse is the
president of the Hula Hoop Foundation and the company gives
$1,000 dollars to the Hula Hoop Foundation, and the company
doesn't manufacture, sell, promote or have anything to do with
Hula Hoops, then shareholders derive absolutely no benefit from
those donations. Of course there is a natural self-interest in
that case for the CEO to keep the donation out of the public
eye. Transparency and integrity are the foundations upon which
shareholders take a stake in our equity markets.
Today over one-half of American families are invested in
the stock market in one form or another. Millions of Americans
are owners of our publicly held companies, and as more and more
Americans take advantage of corporate ownership to secure their
financial future, they assume a greater role in responsible and
judicious charitable giving. Shareholders cannot participate in
this great tradition unless they have access to this
information.
I requested that the SEC do a study on the feasibility of
this bill, and the SEC did report back earlier this year and
concluded, ``The corporate charitable disclosure requirements
in H.R. 887 would be feasible in that companies are capable of
tracking and disclosing this information to investors.''
I would also like to note a small utterance by the SEC
Chairman in a 1995 speech on disclosure. Chairman Levitt began
by quoting Samuel Johnson saying, ``Where secrecy or mystery
begins, vice or roguery is not far off.''
I turn to the distinguished gentleman from Massachusetts,
Mr. Markey.
Mr. Markey. Thank you very much, Mr. Chairman. And I thank
you very much for ensuring that we would have this very
important hearing this morning which I hope can ultimately lead
to legislative action.
I am a cosponsor with you, Mr. Chairman, of H.R. 1089, The
Mutual Fund Tax Awareness Act. This bill would direct the SEC
to issue rules to ensure that mutual fund investors receive
disclosure regarding the after-tax performance of their mutual
funds. This type of information can be very useful to investors
in combination with other types of disclosures required under
existing rules in making an informed investment decision
regarding the impact of capital gains on the overall
performance of a mutual fund.
While such disclosures, like all historical data regarding
the past performances of a fund, does not have precise
predictive value, it is nevertheless useful and important for
investors to receive that type of information.
The fact is because this industry is so competitive and
because there are so many funds out there, factors such as fees
and tax-adjusted performance can be a significant and material
factor to an investor in choosing which fund to invest their
money. The more information an investor has, the more likely
they are going to make an informed decision. That is ultimately
the only goal of this legislation. To put the information in
the hands of the investor to as a result make them even more
knowledgeable and then with the guarantee that nothing is
guaranteed, they can make their investments in the mutual funds
of their choice.
So I hope, Mr. Chairman, that we can move forward on that
legislation. I look forward to hearing from expert witnesses
and I yield back the balance of my time.
Mr. Gillmor. Thank you, Mr. Markey.
[Additional statements submitted for the record follow:]
Prepared Statement of Hon. Michael G. Oxley, Chairman, Subcommittee on
Finance and Hazardous Materials
Today this Subcommittee will focus on two bills drafted by my
colleague, Congressman Gillmor. Both of these bills, which I cosponsor,
would provide investors with better investment information by mandating
certain disclosures. Because educated investors make better decisions
than those without reliable information, these bills will benefit
investors in our country and throughout the world.
The first bill we'll consider, H.R. 887, would require corporations
to provide their shareholders with certain information about corporate
giving. Responsible corporations play a major role in funding not-for-
profit organizations, and no one in the Congress wants to see
corporations stop these beneficial activities. At the same time,
corporations are under no obligation to disclose to their shareholders
where shareholder money is being donated, even if the money is being
funneled to a not-for-profit on which a director or a director's spouse
serves, or to groups opposed by the majority of shareholders. While
many corporations have taken it upon themselves to provide their
shareholders with information about their charitable giving, most
corporations still do not. Since corporate gifts are donated out of
shareholder earnings, it is only reasonable to provide shareholders
with information about where the money, which would otherwise be
returned to them in the form of a dividend, is being spent.
In our second panel we'll consider H.R. 1089, the Mutual Fund Tax
Awareness Act, a bill which would provide mutual fund shareholders with
better information about their funds' rates of return. According to
Morningstar, 180 of the 756 all funds, or nearly one in four funds,
which have been in existence for the past ten years have lost more than
three percentage points per year on their claimed rates of return to
taxes. The funds most likely to lose percentage points are those with
high portfolio turnover, because if the fund manager is frequently
turning over short-term gains in searching for better investments, the
investors will have to pay taxes on this turnover on a yearly basis.
Despite this fact, the overwhelming majority of funds still do not list
performance figures on an adjusted, after-tax basis, even though they
do list performance rates net of fees and expenses. This means that if
an investor buys into a fund which claims a rate of return of 15%, but
the investor isn't provided with information showing that the adjusted
rate of return for the fund was only 10% after the investors paid their
taxes, then that investor may have missed out on the opportunity of
buying into a fund which better takes into account investor tax
consequences when managing the fund.
I want to commend Congressman Gillmor on his hard work in drafting
these bills. They reflect a reasonable compromise between competing
interests. I look forward to working with the members of this
Subcommittee to ensure that investors are provided better information
about their investments.
______
Prepared Statement of Hon. Tom Bliley, Chairman, Committee on Commerce
Mr. Chairman: It goes without saying that investors, and potential
investors, benefit from reliable investment information. This
investment information takes many forms. Today's hearing will focus on
one form of this information: mandated corporate disclosure.
Specifically, this hearing will consider two bills drafted by my
colleague, Congressman Gillmor.
The first bill upon which the Subcommittee will focus, H.R. 887,
would amend the Securities and Exchange Act to require that
corporations disclose certain information concerning their charitable
giving. While there is no doubt that corporate giving is essential to
the missions of many not-for-profits, at the same time it must be
remembered that the money being given to these groups belongs to the
shareholders, not the corporate board. It is important to give these
shareholders more information about where their money is being spent,
so we need to learn whether this bill would effectively accomplish that
objective.
The second bill, H.R. 1089, would require that the S.E.C. amend
their regulations to require improved disclosure of mutual fund
returns. It is a common industry practice to report mutual fund
performance figures net of expenses and fees, but not net of taxes.
Given that many non-index funds experience a high rate of turnover in
their portfolios yearly, because investors must pay taxes on this
turnover the actual rate of return investors enjoy frequently is less
than what is reported by the funds. Providing investors, and potential
investors, with information about the after-tax effects of portfolio
turnover will better enable investors to properly choose the mutual
fund which best suits their investment needs.
Mr. Chairman, I commend Congressman Gillmor for his work on these
bills, and you for scheduling this hearing. I look forward to hearing
from our witnesses.
Mr. Gillmor. We will proceed with Robert Thompson, who is
from the University of Washington School of Law in St. Louis.
Mr. Thompson.
STATEMENTS OF ROBERT B. THOMPSON, GEORGE ALEXANDER MADILL
PROFESSOR OF LAW, WASHINGTON UNIVERSITY; AND JAMES L. MASON,
DIRECTOR OF PUBLIC AND COMMUNITY AFFAIRS, EATON CORPORATION
Mr. Thompson. Thank you, Mr. Chairman. I am Robert Thompson
of St. Louis, Missouri. I am a law faculty member at Washington
University and Director of the Center for Interdisciplinary
Studies at the Washington University School of Law. My
statement is on behalf of myself and Professor Charles Elson
who is a professor at Stetson University, a frequent writer
about corporate governance and in fact a director to American
corporations.
I speak this morning about H.R. 887 which would require
corporate disclosure of charitable contributions. We believe
that would be a vital and welcome addition to a well-
functioning corporate system and could help ensure confidence
and encourage participation in our Nation's capital markets.
The corporate forum permits a specialization of function
between managers and shareholders. It is one of the most
distinctive parts of corporate law that separates and
facilitates an efficient management structure and it permits
the corporation to adapt to changed circumstances which is
essential in our modern economy.
At the same time, separation creates possible agency
problems in that directors are given control over large pools
of funds invested by the shareholders. Disclosure is the
central mechanism used by Federal law to enable shareholders to
effectively exercise their voting and other rights available to
them under State corporate law. Disclosure of material
charitable contributions, as would be required by H.R. 887, is
consistent with the disclosure currently required under the
Federal securities law. The more specific disclosure that would
be required by this bill where there is a possibility of a
conflict of interest as to the corporate insiders and the
beneficiary of the corporate charitable contribution is
consistent with the focus in Regulation S-K on disclosure
relating to comment of interest generally.
As with other expenditures of corporate money, shareholders
desire that charitable contributions reflect a corporate
purpose and do not simply become a gift of corporate assets to
benefit the managers who direct the funds, but with no
financial or emotional benefit to the shareholders themselves
and to their collective enterprise.
Today's corporate philanthropy sometimes functions to
promote and aggrandize corporate managers with the benefit and
the credit for the donations flowing to the individuals without
any corresponding benefit to the entity and its owners.
Consider the well-publicized case of Occidental Petroleum.
When its long-time CEO, Armand Hammer, was unable to obtain
satisfactory terms as to the donation of his art collection to
the Los Angeles County Museum of Art, he turned to the company,
Occidental, to build a museum to house the collection. The cost
of the new building, the renovation of space for the museum's
use in Occidental's headquarters next door, and property taxes
and annuities to help fund the museum's initial operations
approached $100 million. The company received some public
recognition in the form of the right to name and use certain
space in the building and certain sponsorship rights. Many
believe the gift did little for the corporation's financial
prospects or its shareholders but did a great deal for Mr.
Hammer's standing in the art community.
A challenge to this action under traditional State law
corporate rules led to a settlement limiting the company's
contributions. As required by appropriate corporate law
procedures, the Delaware chancery court was asked to approve
the settlement, but its language in doing so provides little
reassurance as to the ability for the current legal structure
to actively address the problem that you have mentioned this
morning. The chancery said and I quote, ``If the court was a
stockholder in Occidental it might vote for new directors. If
it was on the board, it might vote for new management. And if
it was a member of the special committee, it might vote against
a museum property.'' But, the court continued, its options are
limited in reviewing the proposed settlement and in fact the
settlement was approved.
This story is sadly not alone in our corporate landscape.
Generally if a manager directs substantial contributions out of
corporate funds to a charity with whom he or she is personally
involved, there is the potential of a conflict of interest. If
the charity has no relationship with the entity's business but
provides the manager some form of personal benefit within the
community, the possibility of self-dealing is real. Such a
manager may not be the best steward of the shareholders's
resources. Knowledge of those facts would clearly be material
to shareholders in evaluating the performance of directors and
directly relevant to their providing proxies to the election of
directors. Current Federal regulation provides for direct
conflict transactions, but does not provide for disclosure of
charitable donations. Shareholders, therefore, cannot readily
ascertain the existence of such a conflict. The House bill will
provide the facts necessary for determining either the
existence of such conflict or even the simple misapplication of
shareholders' investment.
While the benefit of such disclosure is substantial, the
corresponding cost is not. Every public company that makes such
charitable contributions annually collects information
regarding those donations for reporting to the appropriate
State and Federal taxation authorities. Requiring the
disclosure of charitable contributions over a threshold amount
will require no more than the repetition of information already
collected and transmitted to government agencies. The
disclosure contemplated by the proposed legislation greatly
benefits the shareholding public at very little potential cost
to the reporting companies. The proposed legislation is a
focused and targeted effort that can be implemented consistent
with existing Federal approach to securities disclosures. We
urge you to make them part of our Federal securities laws.
[The prepared statement of Robert B. Thompson follows:]
Prepared Statement of Robert B. Thompson 1 and Charles M.
Elson 2 regarding H.R. 887
---------------------------------------------------------------------------
\1\ George Alexander Madill Professor of Law and Director, Center
for Interdisciplinary Studies, Washington University School of Law, St.
Louis, Missouri. Professor Thompson has taught corporations and
securities law for more than 20 years. He is co-author of a
corporations casebook widely used in American law schools and is a
former chair of the Section of Business Associations of the Association
of American Law Schools.
\2\ Professor of Law, Stetson University School of Law, St.
Petersburg, Florida. Professor Elson specializes in corporate
governance research and is a director of two publicly held American
companies. He is a member of the Advisory Council of the National
Association of Corporate Directors; he organized a national working
group of lawyers, investors, and law professors to discuss possible
language and approach for this bill in 1998 and a seminar on corporate
philantrophy in 1997.
---------------------------------------------------------------------------
H.R. 887 requiring corporate disclosure of material charitable
contributions is a vital and welcome part of a well-functioning
corporate governance system that can insure investor confidence and
encourages active participation in the national capital markets. It
makes necessary changes that can be implemented at a minimal cost.
The corporate form permits a specialization of function between
directors and shareholders, for example, that facilitates an efficient
management structure and permits the corporation to adapt to changed
circumstances. At the same time, this separation creates possible
agency problems in that directors are given control over large pools of
funds invested by the shareholders. Disclosure is the central mechanism
used by federal law to enable shareholders to effectively exercise
their voting and other rights available to them under state corporate
law.
Disclosure of material charitable contributions as would be
required by H.R. 887 is consistent with disclosure currently required
under federal securities laws. The more specific disclosure that would
be required when there is the possibility of a conflict of interest as
to a corporate insider and the beneficiary of the corporate charitable
contribution is consistent with the focus in Regulation S-K, for
example, on disclosure relating to possible conflicts of interest.
As with other expenditures of corporate money, the shareholders
desire that charitable contributions reflect a corporate purpose and do
not become simply a gift of corporate assets that benefits the manager
who directs the corporate funds with no financial or emotional benefit
to the shareholders themselves and their collective enterprise. Today's
corporate philantrophy sometimes functions to promote and aggrandize
corporate managers, with benefit and credit for the donations flowing
to the individuals without any corresponding benefit to the entity and
its owners. Consider the well-publicized case of Occidental Petroleum
Corporation. 3 When its longtime CEO Armand Hammer was
unable to obtain satisfactory terms as to the donation of his art
collection to the Los Angeles County Museum of Art he turned to
Occidental to build a museum to house his collection. The costs of the
new building, renovation of space for the Museum's use in Occidental's
headquarters next door, property taxes and an annuity to help fund the
museum's initial operations exceeded $100 million. The company received
some public recognition in the form of the right to name and use
certain spaces and certain sponsorship rights. Many believe that the
gift did little for the corporation's financial prospects or its
shareholders but did a great deal for Mr. Hammer's standing in the art
community.
---------------------------------------------------------------------------
\3\ See Kahn v. Sullivan, 594 A.2d 48 (Del. 1991); see also Nell
Minnow, What's Wrong with These Pictures? The Story of the Hammer
Museum Litigation, in Law Stories 101 (Gary Bellow & Martha Minnow,
Eds. 1996).
---------------------------------------------------------------------------
A challenge to this action under traditional state law corporate
rules led to a settlement limiting the company's contributions. As
required by appropriate corporate law procedures, the Delaware Chancery
Court approved the settlement but in language that provides little
reassurance for the ability of the current legal structures to
adequately address this problem: ``If the Court was a stockholder of
Occidental, it might vote for new directors, if it was on the Board it
might vote for new management and if it was a member of the Special
Committee, it might vote against the Museum project. But its options
are limited in reviewing a proposed settlement . . .'' 4
This story is sadly not alone in our corporate landscape. 5
---------------------------------------------------------------------------
\4\ Sullivan v. Hammer, No. 10823, 1990 Del. Ch. LEXIS 119, at *12
(Del. Ch. Aug. 7, 1990) aff'd sub nom., Kahn v. Sullivan, 594 A.2d 48
(Del. 1991).
\5\ See also Jayne W. Barnard, Corporate Philanthropy, Executives'
Pet Charities and the Agency Problem, 41 N.Y.L.S. L. Rev. 1147, 1160-64
(1997) (examples of sizeable corporate contributions connected to CEO
preferences).
---------------------------------------------------------------------------
Generally, if a manager directs substantial contributions out of
corporate funds to a charity with whom he or she is personally involved
there is the potential of a conflict of interest. If the charity has no
relationship with the entity's business, but provides the manager some
form of personal benefit within the community, the possibility of self-
dealing is real. Such a manager may not be the best steward of the
shareholders' resources. Knowledge of those facts would clearly be
material to shareholders in evaluating the performance of directors,
and directly relevant to their providing proxies for the election of
directors. Current federal regulations provide disclosure for direct
conflict transactions, but do not provide for disclosure of such
charitable donations. 6 Shareholders therefore cannot
readily ascertain the existence of such conduct, either malignant or
benign. The House Bill will provide the facts necessary for determining
either the existence of such conflicts of interest or even the simple
misapplication of shareholders' investment. Information such as this is
necessary to the shareholder's informed evaluation of company
management which in turn is vital to a properly functioning capital
market.
---------------------------------------------------------------------------
\6\ See Faith Stevelman Kahn, Legislatures, Courts and the SEC:
Reflections on Silence and Power in Corporate and Securities Law, 41
N.Y.L.S. L. Rev. 1107 (1997).
---------------------------------------------------------------------------
While the benefit of such disclosure is substantial, the
corresponding cost is not. Every public company that makes such
charitable contributions annually collects information regarding such
donations for reporting to the appropriate state and federal taxation
authorities. Requiring the disclosure of charitable contributions over
a threshold amount will require no more than the repetition of
information already collected and transmitted to governmental agencies.
The disclosure contemplated by the proposed legislation greatly
benefits the shareholding public at very little potential cost to the
reporting companies.
The proposed legislation is a focused and targeted effort that can
be implemented consistent with the existing federal approach to
securities disclosure. It applies only to reporting companies (and
similar companies regulated under the Investment Company Act.)
Subsection 1 requires disclosure of contributions to nonprofits when an
issuer's director officer or control person (or a spouse of one of
those) is a director or trustee of the nonprofit. It will require
disclosure of contributions only above a threshold amount as designated
by the Securities and Exchange Commission (``SEC''). Subsection 2
requires additional disclosure of the total value of contributions made
by a corporation and individual disclosure above a threshold that will
be designated by the SEC. Unlike the disclosure in the previous
section, this disclosure would appear not in the proxy report sent to
all shareholders but in a filing as designated by the SEC. Because the
reason for such disclosures differ from the reasons for conflict of
interest disclosure, the nature of the disclosure may also differ.
7
---------------------------------------------------------------------------
\7\ See Melvin Aron Eisenberg, Corporate Conduct That Does Not
Maximize Shareholder Gain: Legal Conduct, Ethical Conduct, The Penumbra
Effect, Reciprocity, The Prisoner's Dilemma, Sheep's Clothing, Social
Conduct and Disclosure, 28 Stetson L. Rev. 1, 25 (1998).
---------------------------------------------------------------------------
These disclosures are consistent with, and considerably less
complex than, existing disclosure as to conflict transactions as found,
for example, in Item 404 of Regulation S-K. They reflect disclosure
priorities found generally in Regulation S-K and other parts of the
federal securities laws. We urge you to make them part of our federal
securities law.
Mr. Gillmor. Thank you very much, Mr. Thompson, and I want
to announce that the record will remain open for others members
to submit in writing their opening statements. James Mason from
Eaton Corporation in Cleveland, Ohio.
STATEMENT OF JAMES L. MASON
Mr. Mason. Good morning, Mr. Chairman. Thank you very much
for the opportunity to appear this morning and talk a little
bit about H.R. 887.
I am Director of Public and Community affairs for Eaton
Corporation, a global manufacturer headquartered in Cleveland,
Ohio. It employs about 65,000 men and women worldwide at about
215 manufacturing sites.
Let me tell you about our overall contributions and
community relations philosophy. As a global company, Eaton
Corporation transcends national borders, crosses State lines
and bridges cultural differences by providing jobs and economic
stability. The company invests in itself and in the future with
little fanfare. As background, we provided about $5 million
last year to deserving nonprofit organizations and communities.
Each year we look at the many causes called to our
attention by our employees and apply our knowledge and skills
to determine where we can provide the most benefit to those in
need. Our first commitment is in those cities and towns and
communities where our employees live and work. We support
programs that aid education and strengthen the community as
well as help those with limited opportunities and few
resources.
No less important than the dollars provided are the many
hours that volunteers devote to making a difference in people's
lives. This is part of the Eaton of which I am most proud.
Across the company there are many unsung heroes who take the
time to engage in these volunteer activities. Each year we
honor those individuals with an award for community service
named after one of our former chairmen, who like many in our
company have had a tradition of volunteerism.
It is clear as we approach the new millennium,
technological advances have not provided the solutions to the
human and social issues of our times. We have an opportunity
and an obligation to strengthen the communities where we live
and work and to help those less fortunate. To do less would be
to deny that corporations have a mission beyond providing jobs
and creating wealth. We believe otherwise, and we act on that
belief.
Our employees consistently give of their time, talent, and
finances to support a variety of noteworthy programs and
organizations. Grants are frequently awarded to organizations
recommended by our employees who are involved in leadership
roles and who are in a position to ensure the effective use of
the company's investment.
It has been our philosophy at Eaton to be open and candid
in disclosing to whom our charitable contributions are made and
the amount of our philanthropy. We do this in a volunteer
manner and share this information with our board of directors,
our employees and grant seekers. I have reports of our
contributions, Mr. Chairman, with my testimony on our total
philanthropy.
In addition to our voluntary disclosure, we also meet with
our board of directors on an annual basis, a committee of our
board of public policy and social responsibility; it is a
chance to view firsthand the projects and priorities that we
are funding.
But I am not sure, Mr. Chairman, that one size fits all.
This works for a company such as Eaton. It has been in our
history. We don't make that much in the way of corporate
philanthropy that it is going to make a difference on the
margin. We try to be supportive of the involvement of our
people. That is where our money flows. I know that you have run
some statistics as to whether this would have an impact on
philanthropy. I am not sure, but I think anything that could
have a possible chilling effect is something that we would not
want to advocate.
I know in talking to colleagues within the philanthropic
community, Mr. Chairman, we have a very different opinion on
this issue. Disclosure, as it indicates, I think is good for
the process. I think mandating the types of elements may not
be, and I would not advocate that.
Thank you very much, Mr. Chairman.
[The prepared statement of James L. Mason follows:]
Prepared Statement of James L. Mason, Director, Public & Community
Affairs, Eaton Corporation
introduction
My name is Jim Mason and I am Director of Public & Community
Affairs for Eaton Corporation. My company is a global manufacturer of
highly engineered products that serve industrial, vehicle,
construction, commercial, aerospace and semiconductor markets.
Principal products include hydraulic products and fluid connectors,
electrical power distribution and control equipment, truck drivetrain
systems, ion implanters and a wide variety of controls. We are
headquartered in Cleveland, Ohio--and employ 65,000 men and women at
215 manufacturing sites in 25 countries around the world. Our 1999
sales are expected to be nearly $9 billion.
background
I am providing testimony in regards to H.R.887 regarding disclosure
of corporate charitable contributions sponsored by Congressman Paul
Gillmor. Let me begin by telling you about Eaton and its overall
contributions and community relations' philosophy.
As a global company, Eaton Corporation transcends national borders,
crosses state lines and bridges cultural differences. By providing jobs
and economic stability, the company invests in itself, in society and
in the future. With little fanfare, Eaton provided nearly $5 million
last year to deserving non-profit organizations and communities.
Each year we look at the many causes called to our attention by our
employees and apply our knowledge and skills to determine where we can
provide the most benefit to those in need. Our first commitment is to
the cities, towns, and villages where our employees live and work. We
support programs that aid education and strengthen the community as
well as help those with limited opportunities and few resources.
Of no less importance than the dollars provided are the many hours
that volunteers devote to making a difference in people's lives. This
is the part of Eaton of which I am most proud. Across the company there
are many unsung heroes who take the time to teach reading to the
illiterate, coach little league softball, organize a school aid program
or reach out in other ways to those in need. Each year we honor several
of these volunteer leaders with the James R. Stover Awards for
Community Service, named after one of our former chairmen, but there
are many, many others who uphold this Eaton tradition of volunteerism.
As we approach a new millennium, it is clear that technological
advances have not provided solutions to the human and social issues
that trouble our times. We have an opportunity and an obligation to
strengthen the communities where we live and work and to help those
less fortunate. To do less would be to deny that corporations have a
mission beyond providing jobs and creating wealth. We believe otherwise
and we act on that belief.
Eaton employees consistently give of their time, talent and
finances to support a variety of noteworthy programs and organizations.
Grants are frequently awarded to organizations recommended by employees
who are involved in leadership roles and who are in a position to
ensure the effective use of the company's investment.
It's been Eaton's philosophy to be open and candid in disclosing to
whom our charitable contributions are made and the amount of our
philanthropy--we do this voluntarily and share the information with our
board of directors, employees and grant seekers. Enclosed with this
commentary are reports of contributions that reflect our total
philanthropy.
What Congressman Gillmor is suggesting with H.R.887 is improved
disclosure, openness and accountability--all very worthwhile goals.
However, what is disturbing, in my opinion, is the provision that
publicly held companies such as Eaton, would be required to list in our
proxy statement, all contributions (amount to be determined by the SEC)
to non-profit organizations that had a board member who is an executive
of the corporation, or is an executive's spouse. Also, disclosure is
required of the total amount of contributions in a year, along with the
name of any non-profit receiving contributions exceeding a certain
amount specified again by the SEC.
I can understand that possibly these provisions were intended to
prevent some individuals from becoming too directly involved on certain
``pet projects'', but we want our executives and our associates
actively involved with organizations and witnessing first-hand the
delivery of services and providing oversight on governing boards. If
the aforementioned provision is enacted, it is possible that a chilling
affect will occur, not only would the non-profit experience some
funding dilemmas, but active involvement would be lost as well.
Although we choose to disclose our philanthropy voluntarily (not in
a proxy statement), many other businesses for a variety of reasons
choose not to disclose in the same manner as Eaton. It's been suggested
that added cost would result from the proposed mandates, I am not
certain as to the amount, but it would have an adverse impact on
corporate philanthropy. And, that is what we don't need today--in the
era of unprecedented economic growth, more corporate philanthropy by
new small and medium sized businesses should be encouraged to do more
for others in need in our society.
Mr. Gillmor. Thank you very much, Mr. Mason.
Let me ask both of you what would be, if any, the
compelling public policy reason for shareholders not to know
this information? Is there any?
Mr. Thompson. Shareholders care about how the corporate
money is spent, and there is a question of materiality in terms
of at what level they would be concerned, but the bill seeks to
address that by not requiring every disclosure but only that
over a threshold. That is in response to the main argument,
obviously.
Mr. Mason. I think on that point, Mr. Chairman, our
shareholders, at least through our board of directors, are
fully informed and the report of contributions that we make
available to the various public is open to shareholders. Do I
send that to every shareholder of Eaton Corporation? I
certainly do not. But it is available, Mr. Chairman, for them
to review.
Mr. Gillmor. One potential concern that you have raised is
that it might have a chilling effect on contributions. Now
there are other companies that publicly disclose, including
some very big ones. Chevron is an example. But in your case,
because you have been disclosing for years--and in fact I have
seen your report, which is very good, and your disclosure goes
far beyond anything that would be called for in this
legislation--does the fact that Eaton discloses have a chilling
effect on what you give?
Mr. Mason. No, I don't think it has a chilling effect. I
guess I am a little concerned that the implication drawn in the
legislation of either the chairman or a member of the board or
spouse would--that there would be something sinister, and maybe
that is not the intended consequence.
We do link a lot of our philanthropy, as you know, Mr.
Chairman, with the involvement. We think that it is important
that our people are not only giving of their own personal
finances, but they are taking the time to have some oversight
and governance on these organizations. I don't see anything
wrong with that. I get concerned that if in the spirit of
volunteerism we lose that pull by mandating certain types of
openness beyond where we are open now.
I think I would rather present this material in this
fashion than include it in a proxy statement, for example, is
what I am saying. I think for every example that Professor
Thompson gave relative to the situation about Mr. Hammer, I
don't think that we see that in corporate America. I can't
speak to that end of it, certainly.
Mr. Gillmor. Let me ask Mr. Thompson, because you have been
involved in this type of legislation and you have heard the
arguments against the disclosure requirement. You have reviewed
the previous bill that I have introduced, and I think many
companies were surprised at how small a disclosure requirement
we actually have in H.R. 887. But from your looking at the
changes which have been made in this bill, do you think any of
those cost or burden arguments have been alleviated in the
current legislation?
Mr. Thompson. Yes, I think the changes from the prior
legislation to this proposal speak to a number of concerns that
were raised about cost and regulation.
This bill is disclosure which is common in lots of areas of
corporate America. Companies do it all of the time. It only
applies to specific disclosures when there is a specific
conflict. There will be a threshold which can speak to the
numbers that you made in your opening statement. If you
eliminate all the small ones, it is not a large number. With
those changes, the burden has been made much smaller.
Remember, the costs generally are not very great because
the information is being collected to be given to the tax
authorities relevant to tax returns. So I think that the
changes have been very responsive to the concerns raised about
the cost and impact.
Mr. Gillmor. Thank you very much.
The gentleman from California, Mr. Cox.
Mr. Cox. Thank you, Mr. Chairman.
I would like to thank our witnesses for being with us this
morning, and I would like to thank Eaton for its enlightened
policy. I think the reason that we are here this morning is to
see whether or not Eaton's enlightened policy ought not to be
the policy generally in a marketplace that is characterized by
full disclosure.
Mr. Mason, I think I share your concern about anything that
would have a chilling effect. I think the chairman's question
about whether your enlightened policy and disclosure causes any
chilling effect gets right to the heart of it. In your view it
does not, but there are certain kinds of transfers of
shareholder wealth for no value--which is what a gift is, it
has to be in return for nothing--that obviously could violate
the fiduciary duty of the officer or director, that obviously
could work to the personal benefit of the person making the
transfer and so on.
There are a number of reasons that I can think of that
shareholders at least ought to have access to that information.
And insofar as the link between officers and directors of the
contributing corporation and directors of the nonprofit, it
seems to me that is exactly the kind of information that
shareholders are already entrusted with when it comes to other
benefits to the directors and the officers of the company in
which they invest.
For example, I think I would make the same argument that
you just made about the value of getting your officers or your
board members involved in a charity that you are contributing
to when it comes to stock options. You know, we give officers
and directors stock options all of the time. There is a
potential conflict of interest there, of course, but for the
most part I think companies and management believe, and
generally investors go along with this, that giving people who
work there a stake in the outcome is a good idea. Yet our
disclosure rules require us to disclose the hell out of this
area to make sure that there is not a conflict of interest.
That didn't stop companies from--do you have stock options?
Mr. Mason. Yes, sir.
Mr. Cox. You bet, and so do most corporate insiders. The
fact that there is disclosure doesn't in any way chill the use.
Why doesn't it chill the use of stock options?
Mr. Mason. Well, Mr. Cox, I am not certain where we are
going on this. We offer stock options to a lot of men and women
within my company, not just the senior officers.
Mr. Cox. But specifically, why does the fact that you have
to disclose the details as an insider transaction, as it were,
not deter you from doing it?
Mr. Mason. It is a good point. We certainly do disclose
that candidly in our proxy statement.
Mr. Cox. By law?
Mr. Mason. By law, on an aggregated basis. There are
certain individuals with their compensation that are outlined.
I think philanthropy and what we are talking about on stock
options, although--I am not arguing with you. We chose to
disclose. We choose to do that on a voluntary basis. I can
understand some organizations not being particularly enamored
with doing that, and I think you and I would know those types
of organizations. I think if you can't stand the heat in this,
you ought not to show your philanthropy.
We are not going to make a major difference with our
corporate philanthropy in health and human services across this
country of ours. We think that we are trying to do those
things, Mr. Cox, on the margin that might make a difference.
Mr. Cox. You want to do your part?
Mr. Mason. Yes, sir. And we would like to have those men
and women who are employees of ours step up to that both from a
volunteer standpoint, giving of their time and talent as well
as some resources, as well as the company matching that
activity. I think the centerpiece for our philanthropy has been
our support of the United Way. For every dollar a man and woman
who works for Eaton contributes, we put in 50 cents. And that
doesn't sound like much until you start aggregating that pot
and it is about $2.5 million that our employees give and we are
doing about 50 percent of that. So aggregating, you are getting
close to $4 million.
Mr. Cox. I think it is going to be very hard for the four
of us to disagree on most of these things because it is rather
obvious that corporate contributions are made for the purpose
of benefiting the general community of which business
organizations find themselves a part. It is well understood
that encouraging employees, management, directors, to
participate in their communities is a good thing, makes them
better workers, makes the community a better place. And it is
all benign.
The very reason that corporations make charitable
contributions is that they wish to show themselves to be good
corporate citizens, and they wish to be good corporate
citizens. For that very reason, many corporations go out of
their way to advertise their charitable involvements. The
disclosure of those charitable contributions would as a result
only further advertise what they already are proud of and what
they want to take credit for and encourage more of.
So what we are talking about here, if there is a chill at
all, is chilling things that for some reason somebody that is
part of the transaction would rather cover up, would rather
keep a secret. And I wonder if I could ask, Mr. Thompson, what
kinds of transactions are those?
Mr. Thompson. They are basically conflict-of-interest
transactions. Your point about not many companies not
disclosing stock options is a strong one. Probably a few more
disclose their charitable contributions because of the benefit
that you just described of being a good corporate citizen, but
not many do.
The SEC study done at the request of the committee has a
survey of the largest 100 corporations, and they tried to get
the information from those companies about their charitable
contributions and it was pretty hard to get the information. So
there was some resistance to that. Where the resistance will be
the most is where there is a specific conflict, a potential for
embarrassment, and they don't want the embarrassment.
Mr. Cox. Let us say that a company has a union and let us
say that the company does not--at least its management does not
wish to antagonize the union, but the company wants to
influence legislation in Washington. Could the company make a
contribution to a nonprofit organization which would then
advertise against the union's position at arm's length and not
disclose that to anybody?
Mr. Thompson. The line between charity and business
expenses is sometimes gray and hard to define, and your example
might well fall into that gray area.
Most of the stories and concerns which have been raised by
charitable contributions have been more directly related to
charity, but it would not exclude the example that you raised.
Mr. Cox. Your concern is officers and directors using
corporate assets to benefit themselves personally; is that what
you think is the garden-variety abuse?
Mr. Thompson. They are given the right how to decide to use
other people's money, and that is done for corporate purposes.
That discretion is sometimes used for charitable contributions
which can be good. But when they get a personal benefit from
that, we have crossed the line from the beneficial use to the
use that should concern us. This legislation tries to disclose
those examples.
Mr. Cox. I take it because the character of the personal
benefit is always going to be in the eye of the beholder--these
are subjective judgments--that you would recommend that
Congress make no attempt to actually regulate corporate gifts
themselves, but rather simply use the disclosure model to let
the market handle it?
Mr. Thompson. Disclosure is the best police officer, and
the market can decide for itself. I would expect that many
corporations would present their charitable contributions the
way that Mr. Mason has described what Eaton does; showing its
commitment to volunteerism. But within that context, there will
be the information for shareholders to evaluate whether or not
directors are getting too close to the line.
Mr. Cox. There is an unchallenged assumption here that it
is the business of corporations in part to contribute money to
their communities. There is another point of view. Milton
Friedman once wrote, ``Few trends could so thoroughly undermine
the foundation of our society as the acceptance by corporate
officials of a social responsibility other than to make as much
money for their stockholders as possible.'' Of course he
fleshed out his reasons for saying that, and they are not
trivial. We are not asking that question here this morning with
the consideration of this bill because the bill essentially
would state in law that this is an acceptable practice; but
should we be concerned in any way at the margin about the
license that this bill would give for corporate philanthropy
which presently appears nowhere in the securities laws?
Mr. Thompson. For much of this century which is now
closing, the law has not permitted those kinds of charitable
contributions by corporations. It has been an evolution over
the last few decades of this century to where that has been
permissible. There is an argument against that which you have
identified and addressed.
The Congress could if it wished take up that point. That is
more likely a question for state corporate law than Federal
securities laws. The reason that it is relevant for Federal
securities laws is that disclosure is the main focus of Federal
law and this bill picks up on that disclosure aspect and says
disclose what you are doing within the bounds of State law.
Mr. Cox. But you are the law professor and I am not. It is
my understanding that there is nothing in the 1933 act or the
1934 act or the Investment Company Act today that in any way
acknowledges that it is an appropriate mission of the
corporation to give away money for no value?
Mr. Thompson. No.
Mr. Cox. So this would be the first time that we are
stating in statute that is okay?
Mr. Thompson. It is saying that if it happens, it needs to
be disclosed.
Mr. Cox. I don't think that you would task the SEC with the
business of drafting regulations to determine at what threshold
corporate contributions are being made if it were verboten.
Mr. Thompson. I think that is a fair statement, yes, sir.
Mr. Cox. I just observe, Mr. Chairman, that ought to at
least counterbalance, or more, concerns about chilling effects
because this is the first time that Congress would be saying
that this is an acceptable use of corporate funds and there are
arguments that it is not.
I thank the chairman.
Mr. Gillmor. Thank you very much, Mr. Cox. That will
conclude our first panel and the hearing on H.R. 887. We will
ask--I want to thank both of you, Mr. Thompson and Mr. Mason,
for coming and helping us out.
We will ask our second panel to come forward.
Let us begin with opening statements. Congressman Markey
who is a cosponsor of this bill, H.R. 1089, has made an opening
statement.
Let me say that similar to mutual fund costs, most
investors in nontax-deferred accounts do not understand how
taxes impact total return, and most fund shareholders probably
don't give much weight to tax considerations.
I would like to thank the chairman of the subcommittee,
Chairman Oxley, and the ranking member, Ed Towns, for joining
me in cosponsoring the legislation I have introduced, as has
Mr. Markey.
This is an effort to provide millions of American
shareholders relevant information regarding their financial
objectives. I want to applaud the mutual fund industry for
giving Americans an easy way to participate in American
capitalism and for the enlightened view that they have by and
large taken toward more disclosure of pre- and after-tax
returns. If you look at the chart, you can see the impact that
taxes have had on mutual fund returns. We have heard about the
magic of compounding, but the magic of compounding doesn't
discriminate. It works equally well with costs and taxes as it
does with return.
The yellow bar shows a rate of return before taxes of the
average mutual fund over the 15-year period ending June 30,
1998 and that was 13.6 percent.
The subcommittee held a hearing last fall on mutual fund
fees and expenses, and the red bar represents the return of the
average mutual fund after fees and expenses. And that is a
return that is disclosed to fund shareholders. The majority of
fund assets are in nontax-deferred accounts, and investors owe
taxes on the distribution a fund makes.
The blue bar represents the total return shareholders get
after they pay taxes, and based on the market return over a 15-
year period, the average tax return or the average mutual fund
represents only 67 percent of the pretax return that is
disclosed to fund shareholders.
If the average annual return continues for another 5 years,
a $10,000 initial investment in the market would have grown to
$208,000. After costs and expenses, that $208,000 is reduced to
$128,000. Finally, after taxes, the shareholder is left with
just $75,000 or just 36 percent of the total market return. In
other words, over 20 years the investor loses $133,000 to costs
and taxes.
So after taxes, the rate of return for the average mutual
fund fell to 10.8 percent. And at the end of the 15-year
period, the after-tax return is only 69 percent of the pretax
return.
It is clear that many mutual fund investors and managers
focus only on investment performance before costs and taxes. As
taxes are just an added cost to investors, fund shareholders
should have an opportunity to judge a fund manager's trading
activities to see how it impacts taxes.
Since we are talking here about taxes primarily derived
from the stock market, here is what I think is an interesting
figure. The Federal Government collected over $23 billion in
taxes off mutual fund trading last year. Now if that were the
only source of income for the U.S. Government, the United
States would rank 150th on the Fortune 500 list based on
revenues and we would be just ahead of Walt Disney and Coca-
Cola.
Are some mutual fund income and capital gains distributions
inevitable? Of course they are. Likewise, many are preventable
as well. If minimizing taxable income is not important to the
fund manager, it certainly is to the shareholder. A tax is a
cost, and to the extent that taxes can represent as much or
more than the cost of managing the mutual fund, I think
investors should be provided this information in a form that is
easily understood. Shareholders incur taxes when a fund makes
income or capital gains distributions. When it sells
securities, realizes a profit, capital gains are incurred and
distributed, and the selling of those securities is a result of
portfolio management decisions. And fund shareholders should be
afforded the opportunity to review what the tax liability is
that is going to be imposed on them.
Now, this bill does not in any way tell a fund manager
when, what, or how frequently to buy or sell. It simply
discloses the tax consequence of those actions.
I am encouraged by the efforts of the members of this panel
and by the mutual fund industry to improve after-tax disclosure
to shareholders. The Investment Company Institute has stated
its support for the bill's objectives, and I am confident that
we will continue to work together in the best interest of
shareholders.
Our panel consists of Joel Dickson, Senior Investment
Analyst of Vanguard Group; Mr. David Jones, Vice President, FMR
Company, the Fidelity Mutual Fund Group; and Matthew Fink, the
President of the Investment Company Institute, and we will
begin with Mr. Dickson.
First, I want to ask Mr. Cox if he has an opening statement
on this legislation.
Mr. Cox. I do not. I am anxious to hear from the witnesses.
Mr. Gillmor. You may proceed, Mr. Dickson.
STATEMENTS OF JOEL M. DICKSON, SENIOR INVESTMENT ANALYST,
VANGUARD GROUP; DAVID B. JONES, VICE PRESIDENT, FMR CO.; AND
MATTHEW P. FINK, PRESIDENT, INVESTMENT COMPANY INSTITUTE
Mr. Dickson. Thank you, Mr. Chairman and members of the
subcommittee. I welcome the opportunity to testify today on the
Mutual Fund Tax Awareness Act of 1999. The Vanguard Group
strongly supports the bill's objective of providing better
information on the actual return of mutual funds for taxable
investors. To date, most investors have little or no idea about
how taxes reduce their returns because the industry generally
has not discussed the tax implications of mutual fund
management.
Taxes are the largest cost of mutual fund investment for
most investors. Based on calculations from Morningstar, the
average domestic equity fund returned about 13.5 percent
annually on a pretax basis over the last 10 years. However,
these funds returned about 11 percent on an after-tax basis, a
difference of 2.5 percentage points per year.
In fact, two funds with identical pretax returns can have
very different after-tax returns. For example, a $10,000
investment in Vanguard Growth and Income Fund would have grown
to about $47,700 over the last decade, about $1,000 more than
in the Vanguard 500 Index Fund. However, on an after-tax basis,
the index fund's total of $42,100 was some $4,600 higher.
Vanguard has long encouraged investors to become more
knowledgeable about the tax costs of investing. Most recently
we began publishing after-tax mutual fund returns. We are the
first mutual fund company to report after-tax returns for funds
other than those that present themselves as tax managed. This
is an important step because tax-managed funds represent less
than 1 percent of industry assets. We believe that our new
disclosure is in lockstep with the objectives of the bill being
discussed today.
I would like to highlight one important aspect of our
calculation. We calculate the return by accounting for the
taxes paid on distributions made by the fund to its
shareholders. The primary advantage of this approach is that it
isolates the tax effects on all shareholders resulting from the
portfolio manager's decisions.
An alternative would be to assume a shareholder sells his
or her fund shares and pays all the taxes. Because this is an
individual decision affecting a particular shareholder, it does
not help investors understand how the manager's decisions
affect performance. Vanguard believes that our calculation
allows for a clear-cut discussion of after-tax returns without
potentially confusing shareholders.
It is important to note that our after-tax calculation or
any after-tax calculation for that matter, is not intended to
represent the exact investment return for any particular
investors. Every individual's return will differ based on his
or her unique tax situation. Rather, our intent is to allow for
relevant comparisons of tax effects across mutual funds with
similar objectives.
Although certain assumptions must be made to compute an
after-tax return, Vanguard believes that we have developed a
presentation that gives relevant, useful information that the
average investor can understand. Our annual report disclosure
closes an important gap in the assessment of a fund's return
and speaks directly to the goals of The Mutual Fund Tax
Awareness Act of 1999. To the extent that others think that our
methodology or presentation can be improved, we would welcome
their input. Thank you very much.
[The prepared statement of Joel M. Dickson follows:]
Prepared Statement of Joel M. Dickson, Principal, The Vanguard Group,
Inc.
I welcome the opportunity to testify today on the Mutual Fund Tax
Awareness Act of 1999 and appreciate your invitation for me to address
this topic. Vanguard strongly supports the bill's objective of
providing to mutual fund shareholders better information on the actual
return of their funds.
the tax cost of mutual fund management
Taxes are the largest cost of mutual fund investment for most
investors. Based on calculations using data from Morningstar, the
average domestic equity mutual fund has lost nearly 2.5 percentage
points per year to taxes on distributions of dividends and capital
gains made to the fund's shareholders. Unfortunately, most investors
have little or no idea about how taxes reduce their returns because the
industry generally does not discuss the tax implications of mutual fund
management.
[GRAPHIC] [TIFF OMITTED] T1039.001
If every fund lost the same amount to taxes each year, then
little useful information would be gained by reporting after-
tax returns. However, funds vary tremendously in the tax
burdens they place on their shareholders. For this reason,
pretax returns can be misleading for shareholders subject to
taxes on the distributions they receive. Although the average
annual tax bite was 2.5 percentage points, the amount lost to
taxes for an individual fund ranged from zero (that is, the
pretax and after-tax returns were equal) to 7.35 percentage
points per year.
Rankings of funds' returns also differed greatly depending
on whether pretax or after-tax returns are used. Of the 547
domestic equity funds with 10 years of returns, 118 (22%) would
have their rankings change by more than 10 percentile points--
i.e., they moved up or down by at least 55 spots in the
rankings--depending on whether they were being evaluated on
pretax or after-tax returns. The differences can be startling.
The fund that lost the most to taxes each year ranked 28th on a
pretax basis, yet fell to 272nd out of 547 funds on an after-
tax basis.
Similarly, two funds that may appear identical on a pretax
basis can have very different after-tax returns. As shown in
the chart below, Vanguard Growth and Income Fund outperformed
Vanguard 500 Index by a slight margin over the past ten years
on a pretax basis. However, after considering taxes, the 500
Index Fund would have generated a substantially higher return.
In other words, an investor in a tax-deferred vehicle--e.g., a
401(k) or Individual Retirement Arrangement--would have been
better off with the Growth and Income Fund. The taxable
investor, on the other hand, would have accumulated greater
wealth with the 500 Index Fund.
[GRAPHIC] [TIFF OMITTED] T1039.002
Performance reporting that considers only pretax returns could lead
taxable investors to believe that the past performance of a particular
fund was much better than it actually was for a taxable shareholder.
Because of these substantial differences in pretax and after-tax
returns, we believe that after-tax returns should be reported in
prospectuses or shareholder reports.
vanguard's efforts to educate shareholders on mutual fund taxation
Vanguard has long encouraged investors to become more knowledgeable
about the tax costs of investing. Most recently, we began publishing
after-tax returns in the annual reports of our equity and balanced
mutual funds. In total, these initiatives represent a natural evolution
of Vanguard's long-standing leadership position in providing clear and
candid disclosure on issues that investors should understand when
evaluating funds' performance. Some other examples of Vanguard's
efforts to communicate the importance of taxes on mutual funds' returns
include:
developing a free, educational booklet, ``Taxes and Mutual
Funds,'' that describes the tax consequences of mutual fund
investment;
adding voluntary disclosure to our prospectuses regarding the
portfolio manager's sensitivity to tax implications when making
trading decisions. In most cases, our actively managed equity
funds are managed for pretax return. In these cases, our
prospectuses state that ``this fund is generally not managed
with respect to tax ramifications'';
launching five ``tax-managed'' funds that are offered only to
taxable shareholders and publishing after-tax returns for these
funds in the 1998 annual report to shareholders; and
reporting estimated dividend and capital gain distributions
well in advance of distribution dates so that shareholders can
assess the impact of purchasing shares before the distribution,
which might accelerate their tax liability.
vanguard's initiative to report after-tax returns
Earlier this month, Vanguard announced that we would start
reporting after-tax returns in the annual reports of all of our
balanced and equity mutual funds. Vanguard decided to publish after-tax
returns for a broad range of funds after considering a number of
options. Calculating and presenting after-tax returns raise a number of
challenges, including what methodology to use and how to explain the
returns to shareholders in a clear and concise manner. Ultimately, we
believe that we succeeded in developing disclosure that meets the
objectives of providing relevant, useful information that the average
investor can understand. An example of our disclosure is presented on
the following page.
[GRAPHIC] [TIFF OMITTED] T1039.003
[GRAPHIC] [TIFF OMITTED] T1039.004
We believe our new disclosure is in lockstep with the objectives of
the bill being discussed today, and I would like to highlight a few key
points of our presentation. We made a conscious decision to publish
after-tax returns in the annual reports only for balanced and equity
funds and not for bond and money market funds. We view the annual
report as the appropriate venue to discuss the impact of the investment
adviser's decisions on investment returns. As previously documented,
tax realizations vary greatly among equity funds because capital gain
realizations resulting from the sale of stocks are largely at the
discretion of the portfolio manager. On the other hand, there is little
ability for bond fund managers to affect the relative after-tax returns
of their funds because interest income received from a bond investment
is not an event that can generally be controlled by the manager.
Although we feel that a discussion of bond funds' after-tax returns
does not warrant discussion in the annual reports, we do make these
returns available through other media (e.g., over the phone or on our
website) for shareholders seeking such information.
Overview of Vanguard's After-Tax Calculation Methodology
Our calculation of after-tax returns makes the following key
assumptions:
After-tax returns are calculated by reinvesting all of the
fund's distributions made to shareholders, less any taxes owed
on such distributions. (Pretax returns are computed by
reinvesting the entire distribution.) In other words, taxes are
owed at the time of the distribution.
We use historical tax rates in the computations. Specifically,
we use the highest individual federal income tax rates in
effect at the time of the distribution (currently 39.6% for
dividends and short-term capital gain distributions and 20% for
long-term capital gain distributions). We make no adjustments
for state or local income taxes.
We assume that the fund shares were retained--not sold--at the
end of the periods shown.
Pre-Liquidation vs. Post-Liquidation Returns
The most important assumption is that we assume no liquidation of
the fund's shares at the end of the measurement period. This approach
may understate the total taxes due for a shareholder who may ultimately
redeem his or her investment and pay additional taxes upon such a sale.
The primary advantage of the preliquidation figure is that it isolates
the effects on all shareholders of the taxes resulting from the
portfolio manager's investment decisions. That is, distribution of
dividends and capital gains result from the fund's portfolio management
activity and are given to all shareholders based on their pro-rata
share of the fund's holdings.
An alternative methodology would be to assume a liquidation of the
fund's shares at the end of the period, whether or not a shareholder
would actually redeem his or her investment. In contrast to the
preliquidation figure, this method tends to overstate the tax impact of
mutual fund investments because it accelerates the tax liability for
the buy-and-hold investor. More importantly, the sale of fund shares is
an individual investment decision that results in a taxable event for a
particular shareholder. It does not help investors understand how the
manager's decisions affected the tax liability of all shareholders in
the fund. Given these considerations, Vanguard believes that a pre-
liquidation calculation is the best approach to assess how a manager's
actions affect the after-tax returns received by shareholders.
Using the Highest Federal Marginal Tax Rates
By incorporating the highest individual federal income tax rate in
effect at the time of the distribution, we are taking the most
conservative approach by illustrating the greatest potential tax impact
to total return. While this methodology will
not incorporate the marginal tax brackets of all our taxable
shareholders, it will ensure that the impact of taxes is not
understated for an individual taxable investor. (We do not incorporate
state and local taxes because of the significant complexity in
calculation and presentation that would result in presenting returns
for all 50 states and the District of Columbia.)
It is important to note that our after-tax calculation is not
intended to represent the exact investment return for any particular
investor because every individual's return will differ based on his or
her unique tax situation. Rather, our intent is to allow for relevant
comparisons of tax effects across mutual funds with similar objectives.
Vanguard's methodology is the same used by Morningstar in their after-
tax return calculations, which allows investors to make an ``apples-to-
apples'' comparison between a Vanguard fund's after-tax returns and an
appropriate peer-group average after-tax return.
That said, we realize that most shareholders do not fall within the
highest federal marginal tax rate bracket--currently 39.6%. However,
the difference between after-tax returns using the highest rate versus
a more-common rate of 28% would be less than 0.4 percentage points
annually for most of Vanguard's equity funds over the last ten
years.\1\
---------------------------------------------------------------------------
\1\ This relatively small difference in after-tax returns between
the 28% and 39.6% tax rates occurs because the tax rate difference
applies only to dividends and short-term capital gains. Over the past
ten years, long-term capital gains have been taxed at the same rate
(28% prior to the spring of 1997 and currently 20%) for all taxpayers
outside of the lowest federal tax bracket. Among Vanguard's equity
funds, long-term capital gains have generally represented the bulk of
the taxable distributions.
---------------------------------------------------------------------------
Given this modest difference in returns, we decided to use the
``highest rate'' methodology because it is the most conservative
approach and because it is much simpler to track the ``highest rate''
over time, rather than trying to determine what historical tax rates
would correspond to today's tax brackets. We believe that it is
extremely important to use historical tax rates in the calculation in
order to capture any tax-related portfolio management decisions made as
a result of anticipated tax rate changes.
summary
You will undoubtedly hear arguments that computing after-tax
returns is a complicated endeavor that may lead to such confusion among
investors that the information could do more harm than good. Although
certain assumptions must be made to compute an after-tax return, we
think these issues can be addressed without sacrificing either the
relevance of the calculation or the clarity of the presentation. In
fact, Vanguard has taken up this challenge, and we believe that we have
developed clear, concise disclosure on the after-tax performance of our
balanced and equity mutual funds. Our annual report disclosure closes
an important gap in the assessment of a fund's return and speaks
directly to the goals of the Mutual Fund Tax Awareness Act of 1999. To
the extent that others think that our methodology or presentation can
be improved, we would welcome their input.
Mr. Gillmor. Thank you, Mr. Dickson.
Mr. Jones.
STATEMENT OF DAVID B. JONES
Mr. Jones. Thank you, Mr. Chairman and members of the
subcommittee. I appreciate the opportunity to testify before
you today regarding H.R. 1089, the Mutual Fund Tax Awareness
Act of 1999. Fidelity Investments supports the bill's goal of
providing investors with access to better after-tax return
information for their funds. We believe investors would benefit
from having a better understanding of the impact of taxes on
their investments and from the development of an industry
standard calculation which would allow relevant comparisons
across different mutual funds.
We note in this respect that mutual funds as a group are
relatively tax efficient investments compared to many other
alternatives available to investors because in contrast to an
investment such as a certificate of deposit or a Treasury bill
which bears interest, mutual funds are allowed to provide
investors with returns taxable at more favorable long-term
capital gain rates and not all of this necessarily is taxable
in any given year.
Now, Fidelity first published after-tax returns for one of
its funds in 1993, and we have developed an approach to
calculating after-tax returns that we believe presents the
impact of taxes fairly and accurately to investors. We have
shared that approach with the SEC and have met with them on
several occasions at their request to discuss some of the
issues associated with this, and some of the very detailed
matters of how the calculation works. But overall, the approach
that we have developed is very similar to the approach
developed by other industry members and analysts of the
investment company community.
Nevertheless, there are some important details and
differences that remain to be resolved.
Now any standardized return calculation does require a
number of assumptions because investors have so many different
tax positions individually. Possibly the most useful figure is
to assume an individual investor in the highest tax bracket
since that maximizes the tax impact, but inevitably this will
be an inaccurate number for those investors in lower brackets,
and importantly, for the very large number of investors who
invest through retirement plans and are subject to completely
different tax regimes.
After-tax returns also vary depending on whether you have
presumed the investor continues to hold the account, so-called
preliquidation return, or if you assume that the investor
redeems their shares and uses the money for some purpose, a
post-liquidation return.
Preliquidation returns will highlight the impact of
dividends and distributions that an investor receives during
the course of their holding period, but doesn't take all tax
liabilities into account because some capital gain liability
remains upon redemption.
As a result, preliquidation returns will tend to be higher.
Post-liquidation returns are, after all, taxes, including
anything due when the shares are redeemed, and including any
exit fees that may be imposed by the fund company. This is
consistent with the approach currently required by the SEC for
pretax total returns. We feel that this gives a more realistic
impression of tax impact for investors, particularly over
longer time periods.
Now since 1993 our approach has been to show both of these
numbers to investors because we believe that it is essential to
see the two of them to truly understand the tax impact.
Relative results can differ. A fund that appears to be have a
superior return on a preliquidation basis may have an inferior
return on a postliquidation basis, and vice versa. That is an
important point. There are some examples of that in my written
testimony.
So finally, I conclude by noting that the competing methods
that we have of after-tax return calculation in the industry
are very similar to each other, and this suggests that this
forms a very sound basis for developing an industry standard.
The next step is to hammer out some very important details and
some philosophical questions ultimately to be arbitrated by the
SEC so that we can have a consistent industry standard that is
efficient for mutual fund companies to produce an effective
tool for communicating to investors.
Thank you.
[The prepared statement of David B. Jones follows:]
Prepared Statement of David B. Jones, Vice President, Fidelity
Management & Research Company
i. introduction
My name is David B. Jones. I am Vice President of Fidelity
Management & Research Company, the investment advisor to the Fidelity
Investments group of mutual funds.1
---------------------------------------------------------------------------
\1\ Fidelity Investments manages more than 280 funds with more than
15 million shareholders. With total assets under management of more
than $833 billion, Fidelity is the largest mutual fund manager in the
United States. Fidelity also makes more than 4,000 non-Fidelity funds
available to investors through its FundsNetwork program.
---------------------------------------------------------------------------
I appreciate the opportunity to testify today on H.R. 1089, the
``Mutual Fund Tax Awareness Act of 1999''. This bill, which has been
introduced by Representatives Gillmor, Markey and nine cosponsors,
would direct the Securities and Exchange Commission (``SEC'') to
develop a requirement pursuant to which mutual funds would disclose the
effects of taxes on returns to fund investors.
Fidelity Investments supports the bill's goals. We believe that
investors would benefit from having access to after-tax return
information for the funds they invest in; that the fund industry would
benefit from having an industry-standard formula for after-tax returns,
so that investors can compare funds on an equivalent basis; and that
ultimately all would benefit from having better information available
about the impact of taxes on fund returns. The mutual fund industry has
built its success on providing investors with the education and the
tools they need to invest responsibly. After-tax returns are one more
tool that investors can use to gain a better understanding of the
investment world and of their financial future.
In addition, we are mindful of the fact that mutual funds as a
group are relatively tax-efficient investments compared to many other
investment and savings alternatives. For example, savings accounts,
certificates of deposit and even U.S. Treasury bills all generate
returns that are 100% taxable, at ordinary income rates, in each year
as the returns are earned. Mutual funds, by contrast, may generate
returns that are wholly or partly taxable at more favorable long-term
capital gain rates, and may allow investors to defer taxes on part of
their returns until they liquidate (redeem) their investments.
2
---------------------------------------------------------------------------
\2\ The tax benefits of mutual funds compared to other investments
can be dramatic. An investor who bought our Fidelity OTC Portfolio on
September 30, 1998 would have earned a 52.10% pretax return through
September 30, 1999. After paying taxes on fund distributions, an
individual investor in the top tax bracket would still have had a
48.86% return, which represents 94% of the pretax result. And after
liquidating the investment and paying all remaining capital gains taxes
(assuming long-term gain rates), the investor would have had an after-
tax return of 40.87%, or 78% of the pretax return. (Source for returns:
Morningstar Inc.) If that 52.10% return had been earned from another
type of investment in the form of interest, the investor's after-tax
return would have been 31.47%, or only 60% of the pretax result,
because 39.6% of the return would have gone to pay federal taxes.
---------------------------------------------------------------------------
Fidelity Investments first published after-tax returns in 1993, in
annual and semiannual reports for a Fidelity bond fund managed for
after-tax results. Although that fund has since been liquidated, today
we continue to publish after-tax returns for Fidelity Tax-Managed Stock
Fund, which also is managed with after-tax results as an explicit goal.
In the years since 1993 we have developed a methodology for
calculating after-tax returns that we believe fairly communicates the
impact of taxes on a shareholder's investment. Other fund complexes,
working independently, have developed competing methodologies, as has
Morningstar, Inc. the well-known third-party analysis firm. While the
methodologies developed by Fidelity, Morningstar and other firms are
remarkably similar in many respects, important differences of opinion
remain. There are still essential details and complex technical
questions that will fall to the SEC to resolve.
Fidelity is prepared to do its part to help arrive at an industry
standard for after-tax returns. We have met with the staff of the SEC
on two occasions in 1999 to share our experiences on this subject, and
have submitted to the staff, at their request, a letter outlining
potential methodologies for calculating standardized after-tax returns
for mutual funds.
The remainder of my testimony discusses aspects of the after-tax
return calculation methodology that Fidelity employs. Some of the more
detailed aspects of that methodology, and some of the remaining open
issues, are discussed in our letter to the SEC staff, a copy of which
is attached as Exhibit 1.
ii. major assumptions needed to calculate after-tax returns
After-tax returns are inherently more complicated than pre-tax
returns, because each investor has a different tax situation. Some may
be in high tax brackets and be very sensitive to taxes, while some may
be in lower brackets and be relatively unconcerned. Some investors are
not subject to individual tax rates at all: corporations, for example,
or offshore investors. Most importantly, many investors buy shares
through tax-deferred retirement plans, and will not be subject to any
taxes on their investments until some time in the future. Tax-deferred
retirement accounts represent more than 50% of most Fidelity funds'
shareholder base by assets.
No one method can give the right after-tax result for all of these
investors. As with any standardized calculation, inevitably the results
will highlight one set of circumstances at the expense of others.
In providing after-tax returns for our tax-managed funds, we have
chosen to calculate results for an individual investor in the highest
marginal tax bracket. This choice implies several limitations: among
other things, it will overstate the impact of taxes for many investors,
because most are not in the highest tax bracket, and it will produce an
inaccurate result for retirement investors, because they are subject to
a different tax regime. However, this choice of tax rates is useful as
a way of highlighting the impact of taxes for the most tax-sensitive
investors.
Other assumptions and choices that must be made in developing a
standard return include: whether to reflect state taxes (we do not),
whether to use current tax rates or historical tax rates for historical
periods (we prefer historical rates), when to assume that taxes are
paid (we reflect them at the time that distributions are made, though
others have suggested December 31 or April 15 of each year as an
alternative), and how to handle special kinds of mutual fund
distributions, such as returns of capital or distributions derived from
real estate investment trusts. These assumptions will have a less
material effect than the choice of a tax bracket, but they must still
be resolved in a standard way for returns to be comparable across
different funds.
iii. pre-liquidation and post-liquidation returns
``Pre-liquidation'' returns are adjusted for taxes resulting from
fund distributions--dividends, capital gains distributions, and other
payments that funds make to their shareholders. Pre-liquidation returns
do not reflect any taxes that may be due when an investor redeems his
or her investment. We sometimes describe them as ``your after-tax
return if you continued to hold your shares.''
We quote pre-liquidation returns for our tax-managed fund because
current income is of great concern to tax-sensitive investors, and pre-
liquidation returns highlight this aspect of mutual funds best. But
because pre-liquidation returns do not reflect the taxes due upon
redeeming shares, they can give a false picture of the impact of taxes
on mutual fund investments: they are ``after-tax'' in a sense, but not
after all taxes.
At current federal tax rates, at least 20% of an investor's gains--
the most favorable tax rate available to investors in the maximum
bracket--will ultimately go to taxes (unless the investor dies before
touching the money, or donates his or her shares before death). Pre-
liquidation returns risk fostering the impression that taxes can be
deferred indefinitely, which is not the case for most investors, and
tend to exaggerate the benefits of tax deferral. As a result, we use
them only in conjunction with ``post-liquidation'' returns, which
reflect taxes due when the investment is reduced to cash that an
investor can use. We sometimes describe post-liquidation returns as
``your after-tax return if you closed your account.''
Post-liquidation returns address other important disclosure
concerns as well. Under current SEC requirements for pre-tax returns,
funds must quote performance net of all exit fees or other charges (if
any) that apply when a shareholder liquidates his or her investment.
Pre-liquidation returns would not ordinarily reflect such charges, and
thus could overstate performance. In addition, current SEC standards
require funds to quote pre-tax returns for 1, 5 and 10-year holding
periods. While a one-year period is relatively short, most mutual fund
investors are likely to sell at least some of their shares before ten
years are up, suggesting that a post-liquidation return may be the more
relevant number.
For all these reasons, we feel compelled to quote post-liquidation
returns as well as pre-liquidation returns, even though post-
liquidation returns are normally lower numbers. However, this is a
question on which reasonable parties may disagree, and it represents
one of the areas where we expect further debate as the SEC decides on
specific requirements.
iv. example of after-tax returns
To illustrate the impact of after-tax return calculations, the
following table compares the returns of Fidelity OTC Portfolio, an
aggressive, actively managed stock fund focused on the over-the-counter
market, and Fidelity's Spartan U.S. Equity Index Fund, a fund managed
to track the S&P 500 index, for periods ended September 30, 1999. The
index fund has generally had lower taxable distributions, because of
its less active management style. However, the relative after-tax
result depends both on the time period chosen and on whether returns
are viewed before or after liquidation (the higher result in each case
is in bold) 3.
---------------------------------------------------------------------------
\3\ Source: Morningstar Inc., assuming maximum individual tax
rates. For these funds Morningstar's calculation methodology is
essentially the same as that used by Fidelity currently, except that
their one-year post-liquidation returns assume long-term rather than
short-term capital gain tax rates apply.
[In percent]
------------------------------------------------------------------------
Index OTC
Fund Fund
------------------------------------------------------------------------
One-year results:
Pretax................................................ 27.54 52.10
Pre-liquidation....................................... 26.87 48.86
Post-liquidation...................................... 21.74 40.87
Five-year results (annualized):
Pretax................................................ 24.76 25.40
Pre-liquidation....................................... 23.65 22.30
Post-liquidation...................................... 20.50 20.08
Ten-year results (annualized):
Pretax................................................ 16.51 18.06
Pre-liquidation....................................... 15.26 14.84
Post-liquidation...................................... 13.61 13.75
------------------------------------------------------------------------
This example highlights the importance of considering both pre-
liquidation and post-liquidation results when considering historical
after-tax returns. The example demonstrates that after-tax returns tend
to be lower than pre-tax returns, and that post-liquidation returns
tend to be lower than pre-liquidation returns. The 5-year results
exemplify how a fund may have a superior pre-tax performance but an
inferior after-tax return. And the 10-year results show how a fund may
have a return that appears superior when viewed on a pre-liquidation
basis, but inferior when viewed in terms of post-liquidation results.
v. conclusion
The mutual fund industry has a long history of working with its
regulators in developing standards for disclosure to investors. When
the SEC developed standard calculations for mutual fund yields and
total returns in the 1980s, they received substantial input from the
industry and others, and took this input into account in designing
final rules. As a result of this thorough, detailed process, the
standard calculations promulgated in the 1980s still work well today.
After-tax return calculations present a similar challenge. Industry
members, working independently, have developed calculation
methodologies that are similar in approach, suggesting that a standard
calculation may be within reach. But important details remain to be
resolved in order to assure that after-tax return calculations will be
efficient for funds to produce and effective in communicating to
investors. We look forward to working with other industry members and
the SEC to develop effective standards.
Fidelity Investments appreciates the opportunity to testify before
the Subcommittee. We support the objectives of the ``Mutual Fund
Awareness Act of 1999''. We will continue to work with the Congress and
the SEC in order to achieve after-tax measurements that will be most
useful to our shareholders.
Exhibit 1
4 August 1999
Susan Nash, Esq., Senior Assistant Director
Division of Investment Management
Securities and Exchange Commission
450 5th Street, N.W.
Washington, DC 20549
Re: Sample Calculation Methodology for Mutual Fund After-Tax Total
Returns
Dear Ms. Nash: As you requested by phone, we have drafted a set of
sample instructions for calculating mutual fund after-tax returns. The
instructions are based on the calculation methodology we used in
calculating after-tax returns for two of our funds that have tax
management as an explicit investment goal: Spartan Bond Strategist,
which operated from 1993 through 1996, and Fidelity Tax-Managed Stock
Fund, which commenced operations in November 1998.
The sample instructions (enclosed) are designed to produce after-
tax returns that would complement standard pre-tax returns calculated
under Item 21(b)(1) of Form N-1A. As a result, they follow the same
basic assumptions as those standard return calculations, including the
assumption of a hypothetical $1,000 one-time initial investment and
deduction of all sales loads and other charges, and assume that after-
tax returns would be calculated on an annualized basis for 1-, 5- and
10-year periods. Similar tax adjustments could also be applied to other
kinds of total returns (such as no-load returns, returns assuming a
series of periodic investments, or returns for alternative time
periods) with equal validity. As you requested, we have supplied
instructions for pre-liquidation and post-liquidation after-tax
returns.
As we have discussed, there is no one after-tax calculation that
will be meaningful for all investors, because their tax situations can
differ so dramatically. Therefore, we necessarily made a number of
assumptions in calculating after-tax returns for our tax-managed funds,
which are reflected in our sample instructions. They include the
following:
1. Individual Tax Rates. We assumed tax rates for individuals, and
assumed shares were held outside a tax-deferred account. A corporate
investor, or an individual buying through a retirement plan, would have
significantly different results: our calculation would not produce an
after-tax return that would apply to them.
2. Historical Tax Rates. We believe that historical tax rates
produce a more accurate result than current tax rates, although this
method requires a rule for selecting historical tax brackets (we have
supplied one possible rule, based on assuming a constant wage adjusted
for inflation). We have not specified a particular tax bracket in the
instructions; for our tax-managed funds, which were designed for
higher-bracket investors, we used the maximum tax bracket, but this may
be too high a rate for the more typical fund investor. We have also
assumed deduction of federal taxes only, in order to produce a number
that could be useful for investors in multiple states, and have not
attempted to include the impact of the federal alternative minimum tax,
which only applies to some taxpayers.
3. Time of Deemed Tax Payment. We have assumed that taxes on
distributions are paid at the time of the distribution, as if they were
withheld from the distributions before reinvestment. Although other
methods could be imagined (redeeming shares from the account to pay
taxes on December 31 or April 15, for example, or assuming taxes are
paid from some separate cash account), we believe this method is the
simplest and involves the fewest assumptions.
4. Special Distribution Characteristics. In addition to ordinary
income dividends and capital gain distributions, funds may have
distributions or other features with more complicated tax consequences.
These may include distributions taxable as returns of capital,
distributions that are partially derived from municipal interest and
therefore are partially tax-free, distributions derived from REIT
income (i.e., recaptured depreciation) taxable at a special 25% rate,
distributions derived from commodities gains taxable at 28%, retained
capital gains taxable at the fund level, and foreign tax credits or
deductions that pass through with respect to foreign source income.
Rather than enumerate how each of these should be handled in an after-
tax return calculation, we have tried to describe more general
principles under which these events would be taken into account based
on their impact on an individual taxpayer.
5. Gains or Losses on Redemption. Taxes on capital gains are
assumed to reduce ending value (and after-tax return), while losses on
redemption are treated as a tax benefit that increases after-tax
return. In effect, the calculation assumes that capital losses can be
used to offset capital gains of the same character (long-term or short-
term), giving rise to a benefit equal to the amount of taxes avoided as
a result. In addition, one essential simplifying assumption has been
made: we recommend that shares acquired through reinvestment be treated
as having the same holding period as the initial investment, so that
gain or loss on shares reinvested in the last year could be treated as
long-term rather than short-term. This greatly simplifies the
recordkeeping required to calculate post-liquidation return, with only
a minor impact on the result.
As you requested, our sample calculations do not include any
provisions regarding whether the calculation methodology should be
permissive (like a non-standard total return, which may be calculated
many different ways) or mandatory (like a money market fund yield,
which may only be calculated according to SEC guidelines). Nor do they
address whether funds would be required to disclose after-tax returns
in a specific document or permitted to disclose them according to a
standard formula if desired. We note, however, that standardization is
especially problematic where taxes are concerned, because investors are
subject to such widely divergent tax regimes. And although the after-
tax calculations we describe have worked well as voluntary disclosure
for our tax-managed products in the past, we have never published
after-tax returns for our other funds and do not have experience as to
how other investors would react to them.
We appreciate the opportunity to assist the Division by describing
our approach to after-tax returns, and look forward to additional
discussions as your proposals progress. If you have any questions,
please contact the undersigned at 617-563-6292 or Deborah Pege at 617-
563-6379.
Sincerely yours,
David B. Jones
cc: Craig S. Tyle, Investment Company Institute
Heidi Stam, The Vanguard Group
enclosure
Methodology for Calculation of Mutual Fund After-Tax Returns
fidelity management & research company draft--august 4, 1999
A. General. After-tax returns should be calculated using the same
assumptions and instructions as for average annual returns under Item
21(b)(1) of Form N-1A, with the exceptions noted below.
B. After-Tax Return (Before Redemption). For purposes of
Instruction 2 to Item 21(b)(1), assume all taxable dividends or other
distributions are reinvested after adjusting the distribution by an
amount equal to the taxes applicable to the distribution. Do not assume
complete redemption of shares as required by Instruction 4 to Item
21(b)(1).
C. After-Tax Return (After Redemption). Assume complete redemption
as provided by Instruction 4 to Item 21(b)(1). In addition to the
adjustments provided in Paragraph B above, adjust Ending Redeemable
Value (ERV) by an amount equal to the capital gains taxes applicable to
the redemption.
Instructions.
1. Historical Tax Rates. Use the federal tax rates applicable to
individual taxpayers as of the historical date of each distribution or
redemption. In determining the historical tax bracket applicable to
each taxable transaction, assume the investor had a constant level of
income (adjusted for inflation) over the period.
2. Distributions. Adjust each distribution before reinvestment by
multiplying the amount of the distribution taxable at a given rate by
one minus that rate. For example, adjust a distribution taxable as
long-term capital gains by multiplying it by one minus the applicable
tax rate for long-term capital gains.
a. The taxable amount and tax character of each distribution should
be as specified by the fund on the dividend declaration date,
but may be adjusted to reflect subsequent recharacterizations
of distributions.
b. In general, distributions should be adjusted to reflect the
federal tax impact on an individual taxpayer. Distributions
that would not be federally taxable to an individual (e.g.,
those taxable as tax-exempt interest or as returns of capital)
should not be reduced before reinvestment.
3. Redemption. Adjust redemption proceeds by multiplying the
capital gain or loss upon redemption by the applicable tax rate and
subtracting the result from ERV.
a. Calculate capital gain or loss upon redemption by subtracting the
total tax basis of the hypothetical $1,000 payment from the
redemption proceeds (after deduction of any non-recurring
charges as specified by Instruction 4 to Item 21(b)). State a
capital gain as a positive number and a capital loss as a
negative number, so that ERV will be adjusted downward in case
of a capital gain and upward in case of a capital loss.
b. In calculating the total tax basis of the hypothetical $1,000
payment, include the cost basis attributable to reinvested
distributions and any other costs basis adjustments that would
apply to an individual investor.
c. When determining the character of capital gain or loss upon
redemption, the fund may assume that shares acquired through
reinvestment of distributions have the same holding period as
the initial $1,000 investment.
Mr. Gillmor. Thank you very much, Mr. Jones.
Mr. Fink.
STATEMENT OF MATTHEW P. FINK
Mr. Fink. Thank you very much, Mr. Chairman. I am pleased
to say that the Investment Company Institute, the trade
association for the mutual fund industry, strongly supports the
bill's objective of improving disclosure to shareholders about
the effect of taxes on mutual fund performance. As a witness on
the previous panel on charitable contributions stated,
disclosure has proved to be the best police officer in a lot of
areas, and it certainly will be in this one. Mutual fund
shareholders who have taxable accounts need to understand the
important impact that taxes can have on their returns.
We have been discussing the relevant issues with both the
bill's sponsors on this subcommittee and with the Securities
and Exchange Commission. I have to say some of the issues are
much more complex than it first appears on the surface, but I
am hopeful that the SEC will come out with a proposal in the
near future. We look forward to working with the SEC to resolve
swiftly these various issues, and to get a final rule in place,
as the prior witnesses said, to set an industry standard. Once
there is a final rule, we hope that rule will meet the needs of
investors, meet the expectations of the sponsors on this
subcommittee, and I think it will enjoy the very strong support
of the fund industry.
To name some of the issues that have to be resolved as a
threshold matter, the SEC will have to decide whether it is
best to expand upon existing disclosure requirements in
prospectuses and annual reports, or to require funds to
calculate one or more after-tax numbers as the other two
witnesses have suggested.
If in fact an after-tax number is used, perhaps in a series
of difficult computational issues, the most significant one is
the one that the two witnesses before me highlighted: whether
the return should simply be based on a preliquidation basis,
which assumes that the investor receives dividends and capital
gain distributions but holds his or her shares after the end of
the period, or instead on a postliquidation basis, which
assumes again that the investor receives distributions, but
also that he or she redeems his or her shares at the end of the
period.
As you just heard, there are different views in the
industry, and this will be probably one of the most important
issues the SEC will have to hammer out. There are other issues.
Just to give you the obvious one that Mr. Jones just mentioned,
which tax rate do we assume?
Both Vanguard and Fidelity have been urging using the
highest taxable rate, which I think is 39.6 percent, but that
applies only to a very small number of fund shareholders. Most
are in far lower tax brackets, so you have an issue of which
tax bracket to use.
But if I had to conclude with one final point, I want to
emphasize how important it is going to be if an after-tax
number or numbers are used. There has to be very careful
textual disclosure of the inherent limitations in the numbers
and of how one should look at them. Otherwise we could all
easily inadvertently mislead investors.
Let me give three possible areas that we have to worry
about. First, investors have to be told that after-tax returns
will vary from investor to investor depending on their Federal
tax rate and their State situation. And of course we have to
make clear to the 50 percent of shareholders who are in tax-
exempt accounts, IRAs, 401(k) plans, that none of this makes
any difference to them.
Second, we have to again tell investors that while taxes
are very important, as indicated by Mr. Gillmor's chart, taxes
are only one important factor to consider. It is not the only
factor.
And third, if I had to stress one point, and as Mr. Markey
stated in his opening statement, it has to be made very clear
to investors that these numbers are in no way predictive of
what is going to happen in the future. You could very easily
have a fund which has been very tax efficient in the past, and
in the new year ahead of us it could have substantial taxable
distributions, in part because the size, scale, and timing of
the distributions often are out of the control of the portfolio
manager of the fund. So we really have to warn investors that
this is not predictive.
I am confident, based on working with people like those on
this panel and with the SEC over the last 28 years, that all of
this can be resolved in SEC rulemaking.
I would like to thank the chairman and the other members of
the committee for their leadership in this area, and we are
hopeful and confident that it will all soon be resolved. Thank
you.
[The prepared statement of Matthew P. Fink follows:]
Prepared Statement of Matthew P. Fink, President, Investment Company
Institute
i. introduction
My name is Matthew P. Fink. I am the President of the Investment
Company Institute, the national association of the American investment
company industry.1
---------------------------------------------------------------------------
\1\ The Investment Company Institute is the national association of
the American investment company industry. Its membership includes 7,729
open-end investment companies (``mutual funds''), 485 closed-end
investment companies and 8 sponsors of unit investment trusts. Its
mutual fund members have assets of about $6.010 trillion, accounting
for approximately 95% of total industry assets, and over 78.7 million
individual shareholders.
---------------------------------------------------------------------------
I appreciate the opportunity to testify today on H.R. 1089, the
``Mutual Fund Tax Awareness Act of 1999.'' This bill, introduced by
Representatives Gillmor, Markey and nine co-sponsors, would direct the
Securities and Exchange Commission (``SEC'') to develop a rule to
require mutual funds to disclose the effects of taxes on returns to
fund investors.
The Institute thanks you for giving us the opportunity to work with
you on this legislation. Ensuring that mutual fund investors understand
the impact that taxes can have on returns generated in their taxable
accounts is entirely consistent with the Institute's long-standing,
strong support for initiatives to improve disclosure to investors.
The industry has taken several steps to promote the disclosure
improvements sought by the legislation. Following the introduction last
year of similar legislation, the Institute formed a task force of its
members to develop approaches for identifying and resolving the complex
issues associated with disclosing after-tax returns. The industry has
had discussions with Mr. Gillmor, Mr. Markey, others of you, and the
SEC regarding after-tax return disclosure issues. We submitted
materials to the SEC in July regarding possible methodologies for
calculating after-tax returns.
We understand that the SEC staff is actively considering this
matter. The Institute is committed to working with the Congress and the
SEC as this process moves forward toward completion.
The remainder of my testimony provides background on the tax
aspects of investing in mutual funds, a summary of current disclosure
requirements and finally a discussion of approaches to after-tax
disclosure and issues raised by these approaches.
ii. tax aspects of mutual fund investing
A mutual fund shareholder invested in a taxable account may be
taxed on his investment in two ways: first, when the fund distributes
its income and net realized gains (whether received in cash or
reinvested in additional shares); second, when the investor redeems
fund shares at a gain (whether received in cash or exchanged for shares
in another fund).
A. Distributions to Shareholders
The timing and character of mutual fund distributions is governed
by the Internal Revenue Code. The Code effectively requires a mutual
fund to distribute all of the income and net gains from its portfolio
investments annually. A fund's distributions may be taxable to the
shareholder in two different ways: (1) as ordinary income (e.g.,
dividends, taxable interest and net short-term capital gains) or (2) as
long-term capital gains (i.e., capital gain dividends attributable to
net long-term capital gains). This is the case whether the shareholder
takes his distributions or reinvests them. Distributions also may be
exempt from tax (e.g., exempt-interest dividends attributable to tax-
exempt interest).
The amount of mutual fund distributions can be affected by a fund's
investment policies and strategies (e.g., depending on whether it has a
policy of actively trading its portfolio) and by factors outside the
control of the fund's investment adviser. For example, a fund that
experiences net redemptions can be forced to sell portfolio securities
to meet redemptions and thereby realize gains that it otherwise would
not.
B. Redemptions by Shareholders
Redemptions (sales) of mutual fund shares result in taxable gain
(or loss) to the redeeming investor (whether the proceeds are received
in cash or exchanged for shares of another fund). This gain or loss is
based upon the difference between what the investor paid for the shares
(including the value of shares purchased with reinvested dividends) and
the price at which he sold them.
All of a fund investor's economic return ultimately is received
either as a distribution or as redemption gain. Consequently, there is
a clear inverse relationship between these two tax consequences. If a
fund makes relatively lower distributions because it does not realize
its gains, gains build up in the fund. Consequently, a redeeming
shareholder will have larger capital gains upon redemption than he
otherwise would have had if the fund had realized and distributed the
gains.2
---------------------------------------------------------------------------
\2\ For example, consider two funds (A & B) each of which has a
$10.00 net asset value (``NAV'') at the beginning of the measurement
period and an $11.00 NAV at the end of the period (before
distributions). The $1 increase in NAV represents a 10% return for the
measurement period. Further assume that Fund A distributes $0.20 per
share and Fund B distributes $0.40 per share on the last day of the
measurement period. An investor in Fund A receives 20% of the return in
the form of a $0.20 per-share taxable distribution, with the remaining
80% of the return presently untaxed in the form of an $0.80 increase
from the original $10.00 NAV. An investor in Fund B, in contrast,
receives 40% of the return in the form of a $0.40 per-share taxable
distribution, with the remaining 60% of the return presently untaxed in
the form of a $0.60 increase from the original $10.00 NAV.
---------------------------------------------------------------------------
C. Nontaxable Accounts
It is important to note that the tax impact discussed above is not
applicable in the case of investors that hold their mutual fund shares
in a tax-deferred account, such as a qualified employer-sponsored
retirement plan (e.g., a 401(k) plan), or an Individual Retirement
Account. As of year-end 1998, 45% of all mutual fund assets (other than
money market funds), and 50% of all equity fund assets, were held in a
tax-deferred account.3
---------------------------------------------------------------------------
\3\ Source: ICI data used in publishing 1999 Mutual Fund Fact Book
(39th ed.).
---------------------------------------------------------------------------
iii. current disclosure requirements
The SEC currently requires that the general tax effect of investing
in mutual funds be disclosed to investors in a plain English narrative
in a fund's prospectus. Mutual funds are required to describe ``the tax
consequences to shareholders of buying, holding, exchanging and selling
the Fund's shares,'' including, as applicable, specific disclosures
that distributions from the fund may be taxed as ordinary income or
capital gains, that distributions may be subject to tax whether they
are received in cash or reinvested, and that exchanges for shares of
another fund will be treated as a sale of the fund's shares and subject
to tax.4 Any fund that may engage in active and frequent
trading of portfolio securities also is required to explain the tax
consequences of increased portfolio turnover, and how this may affect
the fund's performance.5
---------------------------------------------------------------------------
\4\ See Item 7(e) of Form N-1A. There are also special disclosures
required of tax-exempt funds.
\5\ See Instruction 7 to Item 4(b)(1) of Form N-1A.
---------------------------------------------------------------------------
All funds are required to provide investors with other information
that may reflect the tax consequences of investing, including the
fund's portfolio turnover rate and the amount of its net unrealized
gains.6 The financial highlights table, which is required to
be included in fund prospectuses and annual reports, also contains
information on a fund's distributions, including distributions
attributable to income and to realized gains.7
---------------------------------------------------------------------------
\6\ Portfolio turnover rate is included in the fund's financial
highlights table (see Item 9(a) of Form N-1A); net unrealized gains are
reported in the fund's financial statements (see Rule 6-05 of
Regulation S-X).
As was noted recently in Morningstar FundInvestor, however, a
fund's portfolio turnover and potential capital gains exposure are at
best only loosely correlated with the level of a fund's taxable
distributions. See Morningstar FundInvestor, Vol. 8 No. 1, September
1999.
\7\ See Item 9(a) of Form N-1A.
---------------------------------------------------------------------------
iv. issues for sec consideration
The Institute agrees with the intent of H.R. 1089 and supports the
approach taken under H.R. 1089, which leaves after-tax disclosure to
SEC rulemaking. Development of this disclosure will require the
consideration of several surprisingly complex issues, some of which may
not be immediately apparent. Thus, this issue is a good candidate for
the rulemaking notice and comment process, where especially complex
issues can be resolved.
A. Improved Narrative Disclosure vs. Providing One or More After-Tax
Return Numbers
A threshold matter that the SEC will have to consider is whether to
expand upon the existing required disclosures, or to require funds to
calculate one or more after-tax return numbers. On the one hand, an
after-tax number might appear more straightforward, as it would not
require a shareholder to review financial statements and apply the
correct tax rates in order to determine the effects of taxes upon his
return. In this way, it also might facilitate the ability of
shareholders to compare different funds.
On the other hand, an after-tax number could have inherent
limitations. As described more fully below, in order to compute an
after-tax number, funds will have to make a series of assumptions, many
of which may not be applicable to any particular shareholder. This runs
the risk of inadvertently misleading investors. It also should be noted
that other financial products, including ones that compete with mutual
funds, are not required to disclose their after-tax returns and thus
comparisons between competing products will not be
possible.8
---------------------------------------------------------------------------
\8\ The SEC may decide to require some funds, but not all, to
disclose their after-tax returns. The SEC could either exempt some
funds, such as money market funds or funds sold principally to tax-
deferred accounts, or only apply the requirement to certain types of
funds, such as funds that hold themselves out as ``tax managed''.
---------------------------------------------------------------------------
Assuming the SEC determines that it is appropriate to require funds
to disclose an after-tax return number, two types of issues will have
to be addressed. The first relates to the actual computation of after-
tax return(s). The second relates to the need to ensure investor
understanding of this information.
B. Computational Considerations
1. After-Tax Calculations on a Pre-Liquidation and/or Post-
Liquidation Basis--Perhaps the most significant computation issue is
whether any after-tax return formula should assume that the investor
continues to hold, or instead redeems, his shares at the end of the
period for which the return is being calculated. If the formula assumes
that he holds the shares (the ``pre-liquidation calculation''), the
after-tax return would be calculated by reducing the fund's total
return by the tax due on distributions made during the measurement
period. If the formula assumes that he redeems the shares (the ``post-
liquidation calculation''), the return would be further adjusted to
reflect capital gains (or possibly capital losses) that would be
realized upon redemption.
The first (pre-liquidation) alternative is intended to disclose the
tax effects only of actions taken by the fund, by reflecting the tax
impact of distributions made by the fund during the measurement
period(s). The second (post-liquidation) alternative, in contrast, also
reflects the potential impact of taxes on (1) unrealized appreciation
in the fund's portfolio and (2) realized but undistributed capital
gains. It thus better discloses an investor's total potential tax
exposure but, in order to do so, assumes that the investor will redeem
his shares at the end of the measurement period, which will probably
not be the case.
2. Federal and State Tax Rate Assumptions--Other significant issues
involve the assumptions regarding applicable federal and state income
tax rates to be used (or not used) in calculating after-tax returns.
For example, which federal tax rate should be applied to income
distributions? As a preliminary matter, the Institute believes that it
may not be appropriate to apply the top federal tax rate (currently
39.6%) to fund distributions, since this rate currently applies to
individuals with a taxable income of more than $283,150, while the
median income of mutual fund shareholders is approximately
$55,000.9 Another issue is whether current or historical
rates should be used. For example, if a fund were computing its 10-year
after-tax return, should it apply the 1990 income tax rates to
distributions made in 1990, or the present day rates? Finally, the SEC
will have to consider whether other taxes, such as state tax, should be
reflected; because of the complexity, the Institute believes that they
should not.10
---------------------------------------------------------------------------
\9\ Source: ICI 1999 Mutual Fund Fact Book (39th ed.) 45.
\10\ Other computational issues are noted in the attached Institute
letter to the SEC.
---------------------------------------------------------------------------
C. Ensuring Investor Understanding of the Information
The after-tax return numbers must be accompanied by disclosure that
informs investors of their appropriate use and inherent limitations.
Otherwise, investors could misunderstand them, and be inadvertently
misled as to the impact of taxes on their returns.
1. After-Tax Returns Vary From Investor to Investor--It must be
clearly disclosed to fund investors that after-tax returns will vary
significantly from investor to investor (unlike pre-tax total returns,
which are equally relevant for all investors in a fund for the
measurement period).11 Thus, any after-tax return disclosed
by a fund may not, and probably will not, reflect a fund shareholder's
own individual circumstances. There are as many after-tax returns for a
given pre-tax return as there are possible combinations of potentially
applicable federal and state tax rates. In addition, different
investors in the same fund may be more or less tax-sensitive depending,
for example, on an investor's ability to offset distributed capital
gains against unrelated, realized losses. And, for some investors--such
as those who hold fund shares in IRAs or 401(k) plans--after-tax
returns will have no relevance.
---------------------------------------------------------------------------
\11\ Under the SEC's methodology for calculating pre-tax total
return, which assumes a hypothetical $1,000 investment and the
reinvestment of all fund distributions, all investors in the fund
throughout the measurement period will have the same return (provided
they have the same account transactions--e.g., all dividends are
reinvested, no other share purchases occur and no shares are redeemed).
---------------------------------------------------------------------------
2. After-Tax Return Numbers Are Not Predictive--There are
``predictive'' limitations to an after-tax return number. As noted
above, the future behavior of some fund shareholders (e.g., redemption
activity) can have a significant impact on other shareholders' after-
tax returns. In addition, ``good'' past after-tax returns could mean
that the shareholder has more potential tax exposure in the future. If
most of a fund's gains were unrealized, those gains could lead to
greater distributions in the coming years.
Thus, the Institute would recommend inclusion of a cautionary
legend, similar to that required for total pre-tax return data,
disclosing that an after-tax return number reflects past tax effects
and is not predictive of future tax effects.
3. Taxes Are One of Many Important Factors When Making Investment
Decisions--While taxes are an important consideration for investors
purchasing fund shares in their taxable accounts, other factors also
are important. For example, investors purchase bond funds to receive
current distributions of interest income, taxable at federal tax rates
up to 39.6% (except in the case of municipal bond funds). A taxable
investor's goal should be, consistent with his investment objectives,
to maximize after-tax returns rather than to minimize taxes.
v. conclusion
The Institute appreciates the opportunity to testify before the
Subcommittee. We support the objectives of the ``Mutual Fund Tax
Awareness Act of 1999'' to improve disclosure to investors of tax
effects on mutual fund total returns. We will continue to work with the
Congress and the SEC in order to achieve a result that will be most
useful for our 77 million shareholders.
Mr. Gillmor. Thank you very much, Mr. Fink.
I might say that I agree that it isn't as simple as it
might first appear. You have the pre- and postredemption
problem, and you have the problem that it is not going to treat
all taxpayers the same, but it is a guide and information that
they don't have now. In that sense I think we at least would
have less confusion.
But let me ask you, Mr. Fink, or any other members of the
panel, do you have any idea at this point how many of those
thousands of mutual funds out there do some kind of after-tax
disclosure?
Mr. Fink. I believe there are now 30 tax-managed funds that
do that, and I think there are something like 200 index funds
which probably also talk about the area.
Mr. Dickson. In terms of actually disclosing an after-tax
return, to my knowledge some tax-managed funds do it, the
numbers that Mr. Fink cited. And to this point, Vanguard just
recently announced that we will be doing it for 47 of our
funds, and also providing the information. Although not in
shareholder reports, for most of the remainder of our funds
through Web site or over the phone.
Other than that, I am not aware of any widespread after-tax
disclosure of returns within the industry.
Mr. Gillmor. All of that is a very small percentage. I
would guess that it is probably a significant improvement over
5 years ago, when I doubt if anybody did it.
Let me ask, Mr. Jones, Fidelity's after-tax returns of
Fidelity's tax-managed fund, what is your evaluation of how
shareholders have received and reviewed that information and
have you given any thought of publishing those kind of returns
on other equity funds?
Mr. Jones. The tax-managed fund shareholders that we have
communicated this sort of return to have, I think, found it
useful generally. I think I take it as a favorable reaction
that we haven't had too many questions. One of our concerns
early on was will people just say, ``What the heck does this
number mean?'' But it seems it has been effective in
communicating to the investors in that category who are
interested in tax impact before they invest in the fund at all.
For our other funds we don't presently calculate the
number. Like most fund groups, we have a lot of information on
tax impact available but most of it is narrative or it is
information like how much distributions have been paid. It
isn't pulled together to a return number. Looking at the
future, I think regardless almost of action by the Securities
and Exchange Commission, I think customer demand will require
us to make that information available on more funds.
Mr. Gillmor. It would seem to me because of the different
ways this can be disclosed, one of the advantages of the
legislation is that we get a uniform disclosure so that
shareholders can really be comparing apples and apples. I will
yield back.
Mr. Markey?
Mr. Markey. Thank you, Mr. Chairman, very much. This is a
very interesting chart that is up in the room today. The
numbers we have before them, that would probably surprise a lot
of investors to see the huge differential that exists between
what they might see in the newspaper and then what ultimately
winds up going to them and the role which taxes plays in
reducing that total.
I think what Mr. Gillmor and I have as our intent is just
that the investor can see this, understand it, and then make
marketplace judgments. And the logical differential, of course,
is the greater the likelihood that an investor will move over
to another fund.
My entire investment is relatively modest in a Fidelity
Spartan Index 500 Fund, and while the fees are slightly higher,
almost infinitesimally higher than Vanguard, Fidelity is in
Boston so I stick with Fidelity. They are the hometown team.
But if combined with the tax management, combined with other
things, the number just kept getting larger and larger, then I
think there would be some reason to reconsider and it is just,
I think, a matter of information that will ultimately determine
the extent to which people are loyal for secondary
considerations and how much the primary considerations are just
overwhelming.
And that is what I think we are trying to achieve here. So
for all of you, I understand that the average portfolio
turnover rate for an actively managed non-index mutual fund has
increased from 30 percent 20 years ago to 90 percent today,
managers who turn over their portfolios without considering the
tax consequences of their decisions on fund investors might
sell stocks in which the fund has made short-term gains, and
other long-term gains without offsets, resulting in higher
yearly taxes for investors.
Again, you do agree, according to your testimony, that the
investors should get the right to the disclosure of the tax-
adjusted performance for that fund. Do you agree with that?
Both of you?
Mr. Dickson. That's correct.
Mr. Jones. Yes.
Mr. Markey. Mr. Fink, you indicated that one of the key
issues for the FCC to make is a decision in the rulemaking
mandated by the Gillmor-Markey bill which would be to determine
what type of after-tax number should be disclosed. The two
options you mention are, No. 1, a preliquidation after-tax
return and two, a postliquidation after-tax return. Does the
ICI have a position at this time as to which of these two
options is preferable?
Mr. Fink. No, particularly because I have my two biggest
members sitting next to me who disagree on this. It has been
talked about with other members but I think it really shows why
you need--not to dodge the question--you really need an SEC
public hearing to hear not only from people in the industry but
the consumer groups, the Consumer Federation, the Association
of Individual Investors. There are very good arguments for
both. And I think you really need a public hearing and an open
dialog, and I personally do not have a view at this point.
Mr. Markey. Thank you, Mr. Fink, for setting up the
discussion. I appreciate it. So, Mr. Dickson, your firm,
Vanguard, has recently begun disclosing after-tax returns. And
I see from your testimony that you favor disclosure of
preliquidation returns. Can you tell us why and why it is
preferable to postliquidation?
Mr. Dickson. Sure. There are a number of considerations.
First of all let me say, and I certainly think I share this
view with Mr. Jones, that we see value in both numbers. It is a
question of presentation and a question of what is in the best
interest to convey the information that we are trying to make.
In the case of Vanguard and our decision to make preliquidation
returns available through shareholder reports, we feel that the
shareholder report talks about the actions of the portfolio
manager that affect all shareholders in the fund. That is, the
distributions of dividends and capital gains that are given to
all shareholders in the fund. That is a preliquidation
calculation.
It is certainly the case, and we have disclosure to this
effect in our presentation, that additional taxes may be owed
if you sell the fund's shares. However, just from one sort of
level, annual reports only go to shareholders that are
currently in the funds, so if you sell your fund's shares, you
are not getting an annual report. Second, we do feel this is
important information, but we feel it doesn't rise to the level
of disclosure in the annual report. Instead, we would plan to
make it available through other vehicles that are customized
ways of showing an individual shareholder return, like through
the Web or over the phone, where people can input, especially
over the Web, different tax rates, different tax treatments, to
be able to calculate their specific tax-adjusted return. For
that level. To keep the clarity brief and to not overwhelm
shareholders with a whole slew of different numbers for
different time periods and different methodologies, we chose
the preliquidation return as the best approach.
Mr. Markey. Mr. Jones, Fidelity favors postliquidation
returns. Could you explain from your perspective the case for
that kind of disclosure as opposed to the Vanguard
preliquidation approach?
Mr. Jones. Absolutely. Just to clarify, our preference of
what we have done in calculating and presenting these figures
in the past has not been to show postliquidation only. It has
been to show preliquidation and postliquidation. So the
differences between Vanguard's approach and ours are actually
perhaps smaller than they might appear. It is truly best seen
as the difference between showing a preliquidation return and
putting in the footnote, ``postliquidation returns may be
lower,'' which is more or less the Vanguard approach, noting
that there may be other taxes due. Or, what we feel is
necessary, saying preliquidation return is X, the
postliquidation return is Y, and actually giving the actual
amount of the difference.
Now, I think we felt that that is necessary in part to make
sure that all taxes are taken into account so that you have a
truly after-tax number and to make sure that any exit fees or
other charges are taken into account as currently required by
other SEC regulations.
Mr. Markey. But in your testimony, just so I can focus in
on this pre- and post- issue, whichever one is going to lead,
in other words, and then have the footnote after the lead
number--what Mr. Dickson is saying in his testimony is that
disclosing postliquidation tax-adjusted returns hinges the
disclosure to the investor's decision to sell the fund rather
than the fund manager's skill of performance in taking account
of the tax consequences of the manager's buy or sell decisions.
What is your response to that argument?
Mr. Jones. I would say it is true that the preliquidation
and postliquidation returns are both based on a hypothetical
investor. Both of them are hypothetical numbers saying let's
assume that $1,000 is put into a fund at a given time, whether
it is pre- or after-tax, in fact. The charges applicable to an
account of that size are taken into account and then in the
case of a preliquidation return, there is an assumption that
the investor hasn't sold any shares and so there is an embedded
tax liability that is unpaid. In postliquidation, there is an
assumption that the investor did liquidate his or her shares.
We feel that is a perfectly reasonable assumption, especially
given the fact that standardized returns are required for
periods up to 10 years. A tax-sensitive investor isn't really
likely to trade out of their fund in 1 year if they are at a
gain because they are a tax-sensitive investor and they would
probably be reluctant to take a short-term gain. But quite a
few investors in mutual funds, although we would like them to
stay with us indefinitely, would have sold some of their shares
by the time 10 years is up.
Mr. Markey. And, Mr. Dickson, Mr. Jones' testimony suggests
that failing to disclose postliquidation returns gives a false
picture of the impact of taxes on mutual fund investors because
they foster the impression that taxes can be deferred
indefinitely, when in fact they can't. How do you respond to
that?
Mr. Dickson. I completely agree with that approach. It is a
question of whether--and, in fact, we address that in our
disclosure by saying that in fact you may very well owe
additional taxes at the time that you sell your fund shares. We
just don't want to deem that redemption on the shareholder,
which is a shareholder-specific action as opposed to a
portfolio management action, and that deeming of redemption may
or may not have actually occurred by the shareholder.
Certainly there is some unrealized potential tax liability,
but to a certain extent you could even construct situations
where you do get out of that tax liability the postliquidation
scenario if the mutual fund shares passed through an estate or
are given away as a charitable contribution. So it is really
focusing on what the manager is effecting in terms of the
performance for all shareholders in the fund as opposed to any
particular shareholder.
Mr. Markey. Thank you, Mr. Dickson. I thank you, Mr.
Chairman, for the extra time. Thank you.
Mr. Gillmor. Before I go to Mr. Cox, I just thought of an
advantage for this bill that I hadn't before and I don't know
if Mr. Markey will agree with this result, but the more that
people know--there are half the families in the country that
own stock--how much their taxes are, we might get a lot more
support for tax cuts here.
Mr. Cox.
Mr. Cox. That is very true.
Mr. Dickson, you mentioned something a moment ago that I
think this whole discussion is pregnant with, and the Web, and
what your firm might do with it. I wonder if I could ask you
what you consider the SEC might do with it, specifically?
Should we imagine a future in which you all provide
standardized inputs to the SEC, they put a calculator up on the
Web as a potential investor and answer a few simple questions
on the SEC's Web site, such as whether I have got any
offsetting capital losses myself, what my tax bracket is and
what State I live in, and let it rip?
Mr. Dickson. Certainly that is possible. We view it--and
certainly the SEC has actually done quite a nice service with
putting up a cost comparison calculator on their Web site.
However, at the end of the day, Vanguard wants to serve
Vanguard shareholders, and to the extent there is a
standardized calculation which this bill would address, then we
can get those same results from doing individualized work on
our own Web site as opposed to sending everything to the SEC.
Mr. Cox. So the advantage would be simply that we would
have the same measures, the same calculator across the industry
rather than boutique calculator here and there and all slightly
different?
Mr. Dickson. Well, the one thing that I would say is there
is certainly a lot more information that you might be able to
pull of shareholders than just some specific items that you
would send, as you were saying. You might be able to customize
it based on information that only--that Vanguard might have for
its shareholders or that the shareholder might have when
logging on. We would just view--in terms of the presentation
ourselves, we would love to do it and in fact we are planning
to do it, to provide customized after-tax return calculations
for shareholders on our Web site.
Mr. Cox. I am not sure whether you think it would be
appropriate for the SEC to do this.
Mr. Dickson. I would say we would prefer to do it
ourselves.
Mr. Cox. Do our other witnesses have a view?
Mr. Jones. I think there are commercial services at present
that are in the business of providing hypothetical performance
information on a pretax basis. The data collection involved is
actually fairly significant as is the data maintenance. It
would be a new role for the SEC to move into that business and
say that they will provide hypothetical return calculations. I
think it is a question for gentlemen like yourselves as to
whether that is an appropriate role. I would expect the same
sort of third-party hypothetical performance providers would
adopt an after-tax calculation, as they have in the past with
other standard return calculations, once they have been
standardized by the SEC.
Mr. Cox. Having heard what your members think, Mr. Fink,
what do you think?
Mr. Fink. I would guess that they wouldn't see anything
wrong with the SEC doing it, but I think they would say better
to have the marketplace do it; and given all the SEC's other
responsibilities, they probably would say have individual firms
do it. That is why I think the industry would come out.
Mr. Cox, I have an add-on which may sound disconnective but
I want to make the point we are talking to two fund groups that
sell directly to consumers basically. That is almost their
entire business. That is a minority. Eighty percent of fund
investors buy through third parties. Now, some of them may use
the Web, but their biggest inclination is probably go to their
broker, financial planner, bank, or employer because they are
buying through third parties. It just changes when you look at
the industry where people get information from. Their
shareholders would go to them. If you are investing in the
other 80 percent, you probably would not go to the web site of
your fund. You would go----
Mr. Cox. If I am buying through a broker, my broker could
do it.
Mr. Fink. I'm sorry?
Mr. Cox. I am sorry, too. I am a little hoarse today. If I
am buying through a broker, my broker could use the SEC site?
Mr. Fink. Yes.
Mr. Cox. It amounts to the same thing?
Mr. Fink. Yes.
Mr. Cox. I have to say I'm a little bit surprised to hear a
discussion about whether we should be doing pre- or
postliquidation returns. Why in the world would we do both?
Mutual funds are supposed to be liquid assets and therefore the
idea of liquidating them shouldn't come as a shock. It is the
very purpose that one would put funds there as opposed to
something less liquid, and I think you ought to be able to get
both answers.
In this era of cheap computing, it is not a great deal of
trouble. It is amazingly routinized. Once you have got the
information, the computer can crank out that data all day long
and customize it for every individual investor at essentially
zero cost. I think the greater concern here is all the
assumptions that have to be made that haven't anything to do
with the complexities of tax law but, rather, there is a built-
in major league assumption up front that the past is prologue,
as Shakespeare would put it, that these are in any way
predictive measures.
And yet because we haven't anything else to go by, I think
we all sort of swallow hard and look at what happened in the
past and make our best guess about the future. We are also
assuming that the taxpayer's current situation, which is all
the taxpayer knows, is going to be the taxpayer's situation in
the future. So you have got a double probabilistic variable
here, that you not only need to concern yourself with whether
the fund is going to be the same as the fund was in the past,
but whether you and your tax situation are the same in the
future. Then you have got us to worry about up here. Is
Congress going to keep the same tax laws in place in the future
that we have had in the past, and we haven't had any discussion
whatsoever about States, but of course that is another layer of
uncertainty. And in all of these sorts of things are what the
market can do.
That is why we despair, ourselves, of trying to provide
direction or guidance to investors on these funds and rather
say, ``Here is the information, you do with it what you will.''
What we are talking about here today is simply getting them the
basic information that they can then evaluate and put in the
Cuisinart with all these variables and uncertainties. I would
hope we would strive to put as much hard data that we know is
available in front of people rather than keep that back,
because even once you have all the hard data, you are still out
there in the middle of guess land. Otherwise, we would all be
wealthy.
Mr. Gillmor. Thank you very much, Mr. Cox. I want to thank
the members of our panel and also the previous panel.
Mr. Markey. Mr. Chairman?
Mr. Gillmor. Yes, Mr. Markey.
Mr. Markey. I thank you very much. First of all, I would
like to follow up on Mr. Cox's line of questioning which I
think focuses on the issue of whether or not the compromise
between the two positions might not be disclosure of both,
which is I think very much an interesting--again, something we
can't determine, but I think that is an interesting approach
that has to be considered, given the technological capacity of
the SEC or any of these firms.
And I would also like to endorse the proposal by the
gentleman from California that the SEC's Web site put data up
mainly because, to be honest with you, that Web site would be
subject to the Privacy Act which governs the retransfer of any
of the information, and as a result people are going to be
putting all of their financial data into a formula which would
be on-line and in the hands of some private-sector company that
would not be secure under our laws. Even the financial services
modernization bill we are passing right now provides no privacy
protection if the information is in the hands of the financial
institution. So if we were going to do it and the individual
wanted to use this type of a service but didn't want to
disclose their entire tax position to Vanguard or Fidelity,
using the SEC under the Privacy Act would probably be a good
alternative.
Mr. Cox. If the gentleman would yield, I think it is very
important. People do feel a little bit more comfortable with
the SEC than they do with some firms, not all of them, Vanguard
and Fidelity, that they have never met before. On the other
hand, I note that there is a subset of the population that
probably feels a lot more comfortable providing their actual
tax information to a private firm than they would to the U.S.
Government.
Mr. Markey. I agree with that. The reality is that the SEC
is probably the most respected agency in the Federal
Government. They are in fact viewed as the cop on the beat, the
guardian of the investor. The greatness of this industry, of
course, is that they come to us with the most impeccable record
of any part of the financial services community and that is to
the credit of the mutual fund industry that they have been so
willing to accept the kinds of regulations that we are even
talking about today to ensure the investor is king.
So hopefully, as a result of legislation, we will be able
to move it forward quickly, pass it in the House, have some
response for the Senate, so that perhaps by the end of next
year investors across this country could have this kind of
information available to them before they are making their end
of year 2000 decisions as to how they want to handle their
investment portfolio.
I thank each of you for your excellent testimony. I yield
back.
Mr. Gillmor. Thank you very much. We stand adjourned.
[Whereupon, at 11:27 a.m., the subcommittee was adjourned.]
[Additional material submitted for the record follows:]
Association of Publicly Traded Companies
October 28, 1999
The Honorable Tom Bliley
Chairman, Committee on Commerce
2125 Rayburn House Office Building
Washington, DC 20515-6115
The Honorable Michael G. Oxley
Chairman, Subcommittee on Finance and Hazardous Materials
2125 Rayburn House Office Building
Washington, DC 20515-6115
RE: Hearing on H.R. 887, Charitable Contributions Disclosure
Dear Chairman Bliley and Chairman Oxley: I am writing on behalf of
the Board of Directors of the Association of Publicly Traded Companies
to express our opposition to HR 887. While we have great respect for
the sponsors of the legislation, we believe that new government
regulation of this type will be counterproductive. I request that this
letter be included in the record of the hearing.
introduction
The Association of Publicly Traded Companies (``APTC'') represents
a wide range of public companies from the newest and smallest to
larger, more established firms. Many of the Association's member
companies are in the high-growth sector of the nation's economy. Our
members are from the every American industry, representing the breadth
and diversity of the entire economy. Moreover, our members develop the
products and services upon which America's long-term economic health
depends. As SEC registered public companies, all of our members would
be required to make the new disclosures that are contemplated in H.R.
887. For all of these reasons, APTC believes that our comments deserve
careful consideration.
the association's position in opposition to h.r. 887
Public companies are eager to communicate with investors on
critical issues. In order to understand their investments, shareholders
need the right kind of information about the company--audited financial
statements, description of the business and the stated vision of the
managers--in a clear concise document. APTC is concerned that too much
of the information currently mandated by the SEC, especially in the
proxy statement, distracts shareholders from the core questions of
sound investing. H.R. 887 would add more distracting information to the
proxy.
Moreover, H.R. 887, if enacted, would continue a disturbing trend
toward more and more mandatory disclosure of non-material information.
Investors should receive information that is material to investment
decisions. Once this ``materiality'' rule gives way to a ``for what
it's worth'' rule, the scope of natural curiosity is the only limit.
There is no need for the new disclosures that H.R. 887 would mandate.
We are mindful of Justice Louis Brandeis' famous admonition that
``[s]unlight is said to be the best of disinfectant . . .'' However, it
is not clear that corporate philanthropy needs disinfecting. We see no
evidence of corporate charitable profligacy. Nor are corporate
directors sacrificing their integrity and violating their fiduciary
duties in exchange for contributions to their favorite charities.
Requiring charitable contribution disclosure in the proxy will be
counterproductive.
Governmentally mandated disclosure about extraneous matters
distracts investors from material information about the company.
Specific information about charitable contribution will send a
confusing and erroneous message, i.e., ``the SEC, your investor
advocate, thinks that this information is important to you as an
investor.'' The limited time that the investor has to study the
potential long-term performance of the company may well be squandered
pondering the significance of the company's charitable contributions.
Unfortunately, the annual proxy materials are already replete with
information of marginal significance to the long-term performance of
the company. In fact, proxy statements are dominated by mandatory
information about executive and board compensation. More information
regarding charitable contributions and their supposed links to officers
and directors will serve to further clutter the proxy statement
The main consequence of the new disclosure will be the unintended ones.
The mandatory disclosure of charitable contributions could have
negative, unintended consequence for both publicly traded companies and
the charities and other non-profit organizations they support.
The only contributions a company ought to make are those that
benefit the business. While a relationship between an officer or
director and the charity may exist, the reasons for any given
contribution are usually many and varied. It is the legal duty of the
managers and the board to insure that the corporate assets are not
wasted. This requirement provides adequate safeguards.
If all contributions must be disclosed, a new rule will likely be
heard in many companies: ``you can't get in trouble for contributions
you don't make.'' Mandatory disclosure of contributions will lead to
the need to justify those contributions and the requirement to be able
to defend those contributions. In those circumstances, a corporation
may conclude that it is prudent to simply avoid making contributions
where the recipient has any relationship to an officer or director.
That course may be a disservice to the charity, and to the officers and
directors. But it may be the prudent course.
conclusion
For the reasons stated here, the Association opposes H.R. 887. We
are very interested in the issues raised by the legislation. We would
be pleased to provide more information should the Committee pursue this
matter further.
Very Truly Yours,
Brian T. Borders
President
cc: Brent Delmonte
Committee Counsel
Committee on Commerce
Washington, DC 20515-6115
______
The Business Roundtable
July 23, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington D. D., 20509
Attn: Brian J. Lane, Director, Division of Corporate Finance
Re: Proposed Disclosure of Charitable Contributions (HR 887)
Ladies and Gentlemen: Thank you for the opportunity to address the
proposed Bill introduced in the House of Representatives (HR 887),
which would require disclosure of charitable contributions by issuers
that have securities registered under Section 12 of the Securities
Exchange Act of 1934, as amended. The Business Roundtable (BRT)
includes the CEOs of many of the country's largest corporations,
virtually all of which are significant contributors to the arts, civic
projects, charities and other worthwhile organizations and activities.
Virtually all of the BRT members and senior executives of many other
major U.S. companies are actively involved in charitable activities
and, consequently, any legislation or regulations impacting such
activities are of concern to the BRT.
The BRT believes the proposed requirement of disclosure of
charitable contributions is unnecessary. For the reasons set forth in
this letter, we believe the proposed disclosure is unnecessary for the
protection of investors and is, at best, overbearing and unnecessarily
burdensome. Many of the companies whose CEOs are members of the BRT
already voluntarily make available reports of their charitable
contributions to interested stockholders, and there has been no showing
that there exists any abuse of corporate-giving programs to warrant the
increased burden associated with the proposed legislative change.
Moreover, if the Securities and Exchange Commission (``Commission'')
were to determine that such disclosure was necessary, it has ample
authority to require it without legislative or regulatory changes.
1. There is no justification for the proposed disclosure requirement.
While some stockholders may have a special interest in knowing to
which charities contributions have been made, no concern of general
interest and materiality to stockholders is raised unless the
contributions are so disproportionately large to the size of the
reporting company as to amount to corporate waste or would otherwise
reach the level where a director can be said to have failed to exercise
his or her fiduciary duties. Under state corporate law, companies and
their directors have a fiduciary duty to stockholders not to waste
corporate assets. The decisions of a corporation on its community
relations and charitable giving programs are quintessential business
decisions, and under state law are within the purview to the board of
directors and management. They involve considerations unique to each
corporation, and its customer base and the communities in which it
operates. Such decisions should not be made based on SEC disclosure
policy or general stockholder referenda, but should be regulated
pursuant to state law corporate governance standards. Further, state
law provides sufficient ability for stockholders to regulate charitable
``gifts'' by their companies through their right to review the books
and records of the company and their ability to present and advocate
stockholder resolutions addressing such activities. SEC-mandated
disclosure, as proposed, regarding charitable contributions would be
tantamount to substituting federal legislation for a matter that is
properly one for state law.
2. Contributions to charitable organizations should be disclosed only
if there is a significant direct or indirect economic benefit
to an insider and the amount of the contribution is unusually
large.
The proposed legislation would require disclosure in proxy
statements and other consent solicitation documents of charitable
contributions in excess of an amount to be determined by the SEC if a
director, officer or controlling person of the donor company, or their
spouse serves as a director or trustee of the charity. While, for the
reasons stated above, we think a general disclosure requirement for
charitable contributions is both bad policy and an unwarranted
intrusion on areas regulated by state corporate governance laws, there
may be a limited number of instances where disclosure may be
appropriate. We believe that if proxy disclosure is required, it should
only be required if an insider serves as a director or trustee of the
charity and there would be a significant direct economic benefit to the
insider. For example, a substantial donation to a ``private
foundation'' controlled by the insiders would generally be disclosable
under the above described standard. This disclosure would be
appropriate because the insider would have discretionary power over the
donated funds after the donation. Similarly, a grant to a research
institution or university for the development of bio-tech products
would be disclosable if the company had a technology development
agreement with the university and a director of the company received
research funds from such contribution. The standard proposed for proxy
disclosure by the proposed legislation seems to imply that disclosure
under all circumstances is warranted because the insider is perceived
as having received a benefit as a result of, or in connection with, the
company's charitable donation. When the insider is not receiving any
significant direct economic benefit from the contribution, no
disclosure should be required. Under all circumstances, the threshold
amount of contribution to a charity before disclosure is required
should be substantial. No disclosure should be required if the
aggregate amount of a company contributions does not exceed 2.5% of
consolidated revenues.
3. The proposed disclosure standards are unnecessarily complicated.
As proposed, the bill distinguishes between proxy disclosure, and
information regarding charitable donations that must be made available
to stockholders annually, in a format to be prescribed by the SEC.
Proxy disclosure is required only if the value of the charitable
contribution exceeds an amount to be determined by the SEC, and then
only if an insider serves as a director or trustee of the recipient
charity. The bills proposed annual disclosure, however, would require
an issuer to make available the aggregate amount of charitable
donations made by it in any given year and, if any one particular
charitable organization received donations in excess of an amount to be
determined by the SEC, the name of such charitable organization and the
value of the contribution made. As proposed, the annual disclosure is
required even if no insider of the donor company serves as a director
or trustee of the recipient charity.
We do not believe that, absent a significant direct relationship
between the charity and an insider of the reporting company, disclosure
regarding charitable donations is necessary for the protection of
investors, or consistent with the Commission's charter and with the
authority of the states to regulate corporate governance. No evidence
has been presented by the proponents of the bill to indicate that such
disclosure will cure a significant level of abuse or provide material
disclosure necessary for the protection of investors. The additional
regulatory burden imposed on the issuer should be balanced against the
benefit to be gained. Unless the amount of contributions are material
to the financial statements or business of the Company we see no reason
why the disclosure of charitable contribution needs to be bifurcated.
We would suggest that any required disclosure be restricted to the
proxy statement and to instances when there is an insider involved with
the charity in the manner we have proposed in 2. above. Many, if not
most, charitable organizations are subject to state and federal
regulatory review (IRS) and substantial financial information is open
for public scrutiny as a matter of law. The bifurcated disclosure
standard is unnecessarily complicated and poses an unnecessary
regulatory burden on an issuer. Rather than imposing different
requirements, one standard for proxy statement and annual report
disclosure should be devised and an issuer should be allowed to
incorporate by reference in its annual report the disclosure in its
proxy statement, as is currently permitted with respect to Items 11
through 13 of Form 10-K.
4. If disclosure is deemed necessary, stockholder proposals with
respect to charitable donations should be precluded.
If an issuer is required to make disclosure about charitable
donations, such disclosure is likely to become the target of greater
special interest group and political criticism regarding its choice of
charities. Charities acceptable or even supported by one stockholder
may be entirely unacceptable to another stockholder. The outcome of
this could very well be a rash of stockholder proposals demanding that
a particular charity be declared ineligible to receive future donations
or that a different charity be the recipient of the company's gifts.
The time and resources required to deal with such proposals alone would
be a sufficient reason to limit the proposed disclosure. If, however,
the proposed bill is enacted, it should at a minimum afford protection
from stockholder proposals by declaring that charitable donations are
``ordinary business'' under the standard of Rule 14a-8(i)(7) and thus
not a proper subject for action by an issuer's stockholders unless the
proponent clearly demonstrates that the relationship to the charity is
significant to the business of the company.
5. The proposed disclosure could have a stifling effect on corporate
charitable donations and is not necessary for the protection of
investors.
We believe that the bill's proposed disclosure requirement could
have a stifling effect on corporate donations. To the extent that the
gift programs of the companies become the target of stockholder
complaints that either disagree with corporate giving generally or the
specific recipients, it is likely that companies will restrict
contributions to avoid the burden of disclosure. The negative impact on
corporate philanthropy will almost certainly exceed any disclosure gain
intended by the proposed statutory change. The central tenet of the
securities laws is the protection of investors. What an investors needs
to know to make an informed investment decision should not be equated
with what a few investors, who may have a special interest or other
non-corporate agenda, would like to know.
6. The legislation is unnecessary.
Finally, legislation on this subject is unnecessary. The Commission
has ample authority under the Securities Act of 1933 and the Securities
Exchange Act of 1934 to require any disclosure relating to charitable
contributions that is actually material to investors.
We would welcome the opportunity for representatives of the BRT to
meet with you on this matter.
Very truly yours,
William C. Steere, Jr.
______
Prepared Statement of Dorothy S. Ridings, President and CEO, Council on
Foundations
The Council on Foundations and its more than 200 corporate
grantmaking members continue to be concerned about the possible
negative effects of H.R. 887 on charitable giving. The bill would amend
the Securities and Exchange Act to require disclosures of contributions
to nonprofit organizations. Although H.R. 887 is an improvement over
similar bills introduced in the last Congress, and although the Council
strongly encourages grantmakers to issue periodic reports informing the
public about their gifts and grants, we question the need for federal
legislation in this area. Particular problems with the bill include the
prospect that it may deter volunteering and diminish giving. In
addition, the measure delegates substantial authority to the Securities
and Exchange Commission without affording necessary guidance on how the
SEC is to exercise that authority. Finally, the bill fails to address
serious issues with regard to the scope of required disclosure.
The Council on Foundations is a nonprofit association of more than
1800 grantmaking foundations and corporations. (A list of our corporate
members is enclosed.) We estimate, based on market projections and
other factors, that the 235 corporate grantmaker members of the Council
will make more than $2.5 billion in charitable gifts in 1999. In
addition to their financial resources, corporations also provide
volunteer time, expertise, and visibility to the organizations they
support. They are a vital and integral part of the charitable private
sector. We hope that you will take our concerns into account as you
consider H.R. 887.
Deterring volunteer activities. The first substantive provision of
H.R. 887 would require publicly traded companies to disclose all
contributions (above an amount to be set by the Securities and Exchange
Commission) that the company makes to a nonprofit organization if a
director, officer, or controlling person of the company is a director
or trustee of the nonprofit. Disclosure also is required if a spouse of
a covered individual serves on the nonprofit's board.
Many companies encourage their employees to become involved in
community organizations, and many employees respond by generously
donating their time to serve on community boards. Many companies also
like to direct their giving to charities with which their employees are
involved. We are deeply concerned that the disclosure requirement will
place a strongly negative cast on this practice, leading key corporate
employees and their spouses to resign their charity board positions
lest they be perceived as having done something wrong. There is much
reason to believe that volunteering by key corporate employees
strengthens the social fabric of their communities, but correspondingly
little evidence that this practice harms shareholders.
Discouraging Giving. The second provision of H.R. 887 requires
publicly traded companies to disclose the names of nonprofits to which
they made gifts and the amount they gave. Again, disclosure would be
required only for gifts that exceeded a minimum amount to be
established by the Securities and Exchange Commission. Currently
corporations can decide whether and how they wish to publicize their
gifts. H.R. 887 would remove this choice.
We are concerned that this Congressional action could have an
adverse impact on charitable giving by publicly traded companies. While
the Council encourages companies to report their philanthropic efforts
to the community, it would be naive not to acknowledge that charitable
giving can be a sensitive issue for many corporations, especially those
that deal directly with the public. We fear that some corporations may
choose to eliminate giving programs rather than make disclosure. Others
may decide to reduce the size of all contributions to a level below
whatever minimum the SEC establishes. We urge you to keep in mind that
corporate giving is an entirely voluntary expenditure. Nothing prevents
a corporation from deciding that intrusive government regulation makes
it undesirable to continue these gifts.
Promoting red tape. Many publicly traded corporations have numerous
operating divisions and subsidiaries, each of which may have its own
budget for charitable giving. If this legislation is enacted some of
these companies likely will be required to invest in new software and
tracking capability to collect and centralize information about the
identity of all recipients and the amount of each gift. This task would
be complicated by the need to accumulate gifts over the course of the
year to determine whether the total exceeded the threshold established
by the SEC. A further difficulty is that the answer to the threshold
question may depend on how the recipient is organized. For example,
because chapters of the American Red Cross are not separately
incorporated, it would be necessary to accumulate all gifts to the
various chapters. By contrast, local YMCAs and YWCAs are separate
corporations (although often with multiple operating units), meaning
that gifts to each corporate entity would be separately tracked.
Absence of necessary guidance to the SEC. H.R. 887 requires the
Securities and Exchange Commission to establish a floor for both
disclosure requirements. The only guidance to the SEC is that the
amount it sets must be one that is ``consistent with the public
interest and the protection of investors.'' The bill leaves the SEC to
guess what this level should be, since even total giving through
corporate giving programs rarely, if ever, rises to the level of
materiality--the standard the SEC normally applies in determining the
need for disclosure. The height of the floor will have a significant
impact on the record keeping burden that H.R. 877 will impose.
A related problem is that H.R. 887 does not include even the flawed
provisions found in earlier versions of this legislation that attempted
to reduce the size and scope of the burden the legislation would place
on corporate givers. Thus earlier versions excluded from disclosure
gifts of tangible property, gifts to public and private educational
institutions, and gifts to local charities. The lack of similar
provisions in this bill means that all gifts must be reported if they
fall above the floor to be established by the SEC. Many corporate
commenters on previous versions of this legislation also pointed out
the burden involved if reportable gifts include all those made by a
corporation pursuant to an employee gift matching program. H.R. 887
does not give the SEC the discretion to adopt a rule excluding matching
gifts, except to the extent that matching gifts falling below the
established floor will not be required to be disclosed.
The legislation also is vague on the gifts that must be disclosed.
While the section heading is titled ``Disclosure of Charitable
Contributions,'' the text of the legislation mandates disclosure in
connection with ``contributions'' to ``any nonprofit organization.''
Charitable institutions--those organized and operated for a charitable
purpose and exempt from tax under section 501(c)(3) of the Internal
Revenue Code--are only one type of nonprofit organization. Examples of
non-charitable nonprofits include trade and professional associations,
civic leagues and social welfare organizations, social clubs, fraternal
organizations, and a host of entities created for various pension and
employee welfare purposes. H.R. 887 requires that contributions to
these entities also would have to be tracked and disclosed.
Normal corporate checks and balances protect investors and the
public. Corporate management generally makes charitable contribution
decisions. Corporate management is directly accountable to the
directors who represent the shareholders. Shareholders who are unhappy
about how their corporation is run have the option of voting to replace
the directors. This system is not perfect. But it is far preferable to
micromanagement by the federal government, particularly in the absence
of any concrete evidence that corporate giving is harming investors or
the public.
In sum, the Council on Foundations is concerned that the risks of
H.R. 887 substantially outweigh its benefits. We urge the subcommittee
to consider carefully the need for injecting federal regulation into a
system that currently works productively to provide substantial private
voluntary support for a wide range of charitable organizations in all
parts of the United States.
______
Prepared Statement of the U.S. Securities and Exchange Commission
Thank you for giving the Securities and Exchange Commission (SEC or
Commission) the opportunity to present this statement concerning the
disclosure of tax consequences of mutual fund investments and
charitable contributions. The Commission fully supports the important
goal of full disclosure, and welcomes this dialogue on these issues.
i. the tax consequences of mutual fund investments
One of the Commission's primary goals with respect to mutual fund
disclosure is ensuring that funds clearly present their performance and
costs to investors. H.R. 1089, the Mutual Fund Tax Awareness Act of
1999, would address an important aspect of this issue, the effect of
taxes on mutual fund performance. H.R. 1089 would require the
Commission to revise its regulations to improve methods of disclosing
to investors in mutual fund prospectuses and annual reports the after-
tax effects of portfolio turnover on mutual fund returns. In fact, as
more fully described below, the Commission staff is already working on
improving disclosure in this area.
Current Disclosure Requirements
Mutual funds currently are required to disclose the following
information about taxes in their prospectuses and annual reports:
Tax Consequences. A fund must disclose in its prospectus the
tax consequences to shareholders of buying, holding,
exchanging, and selling the fund's shares, including the tax
consequences of fund distributions.
Portfolio Turnover. A fund must disclose in its prospectus
whether the fund may engage in active and frequent portfolio
trading to achieve its principal investment strategies and, if
so, the tax consequences to investors of increased portfolio
turnover and how this may affect fund performance. A fund also
must disclose in its prospectus and annual reports the
portfolio turnover rate for each of the last 5 fiscal years.
Distributions. A fund must disclose dividends from net
investment income and capital gains distributions per share for
each of the last 5 fiscal years in its prospectus and annual
reports.
Staff Consideration of Mutual Fund Tax Disclosure
The Commission staff has been considering whether mutual fund
disclosure requirements could be revised to provide investors with a
better understanding of the tax consequences of holding and disposing
of a fund, the relative tax efficiencies of different funds, and how
much of a fund's reported pre-tax return will be paid out by an
investor in taxes. There is no direct correlation between the portfolio
turnover rate, which currently is disclosed, and shareholder tax
consequences. For example, a fund with high portfolio turnover may
produce relatively low taxable gain to investors if it offsets realized
gains with realized losses.
The Commission staff is considering whether there are other
measures that could be used to convey mutual fund tax consequences that
are understandable to investors and not unduly burdensome for funds to
compute. Standardizing disclosure of the tax consequences of a mutual
fund investment is complicated because different fund investors are in
different tax situations and, therefore, may experience different tax
consequences from the same fund investment.
The Commission staff's considerations have focused on after-tax
return, a measure of a mutual fund's performance, adjusted to
illustrate how taxes could affect an investor. (The calculation of
after-tax return requires a number of assumptions about the investor's
tax situation, such as his or her tax bracket.) The staff is
considering two separate measures of after-tax return:
Pre-Liquidation After-Tax Return. This measure assumes that an
investor continues to hold the fund at the end of the period
for which the return is computed. It measures only the taxes
resulting to the investor from the portfolio manager's purchase
and sale of portfolio securities.
Post-Liquidation After-Tax Return. This measure assumes that
an investor sells the fund at the end of the period for which
the return is computed and pays taxes on any appreciation (or
realizes losses). It measures both the taxes resulting from the
portfolio manager's purchase and sale of portfolio securities
and the taxes incurred by shareholders on a sale of fund
shares.
These measures of after-tax return could help investors compare the
after-tax returns of different funds and gain an understanding of the
impact of taxes on a fund's reported pre-tax return.
Anticipated Commission Action
The Commission staff currently is preparing a recommendation to the
Commission that it issue proposed rule amendments intended to improve
the disclosure of the tax consequences of mutual fund investments. The
proposed rule amendments, if issued, would be promulgated pursuant to
the Commission's existing authority and would be the subject of public
notice and comment.
ii. disclosure of charitable contributions by public companies and
mutual funds
H.R. 887 is a bill that would require public companies and mutual
funds to disclose information about certain of their contributions to
non-profit organizations where an insider of the company, or a spouse,
is a director or trustee of the organization. In addition, public
companies would be required to make available disclosure of the total
value of contributions made and identify the donees and amounts
contributed if they exceed a dollar threshold established by the
Commission.
SEC Staff Study
At Representative Gillmor's request, the Commission staff has
studied H.R. 887 and previous versions of the legislation. In fact, the
staff requested comment from the public concerning the costs and
benefits of the earlier legislation (H.R. 944 and 945). Nearly 200
persons commented. The vast majority of the commenters opposed the
previous legislation. The commenters supporting disclosure argued that
improved disclosure would reduce abuse, improve accountability, reduce
shareholder distrust, provide another basis on which to assess the
judgment of management, and build goodwill with the companies'
customers and community. Opponents of disclosure argued that it would
be costly to track small contributions, especially for large companies.
They believed that companies would reduce the amount of gifts to avoid
disclosure or avoid giving to controversial charities. There was
concern this disclosure could be used for political or personal
agendas.
After studying the issue, the Commission staff concluded that
imposing the corporate charitable contributions disclosure requirements
in H.R. 887 would be feasible in that public companies are capable of
tracking and disclosing this information to investors. Many companies
currently collect charitable contribution information for tax purposes,
and a small number already voluntarily disclose this information to the
public.
Current Disclosure Requirements
Currently, shareholders have a right to make proposals in the
company's proxy statement to provide disclosure of charitable
contributions. Those proposals have not attracted substantial support
from shareholders. The Business Roundtable has commented that few
shareholders request information regarding charitable contributions
from companies that provide this information voluntarily. This leads us
to believe that a significant majority of shareholders may not consider
this information to be important.
In recent years, the Commission has been focusing much of its
efforts on streamlining disclosure and mandating plain English.
Charitable contributions account for a small portion of most companies'
financial activities. We are cautious about adding disclosure that
would add to the volume of detail given to investors without providing
material information.
In the course of reviewing H.R. 887, the Commission staff
identified additional practical issues that may affect the
implementation of disclosure requirements for corporate charitable
giving. Although companies already track the amount of their charitable
contributions and to whom they are made for tax purposes, they may not
have in place mechanisms to identify gifts to organizations affiliated
with corporate insiders and their spouses, in part because they are not
currently required to do so. Also, depending upon the dollar thresholds
for disclosure, the amount of disclosure and the corresponding cost
burden will vary significantly. Finally, there are other technical
issues that the staff would be pleased to discuss.
iii. conclusion
The Commission supports the goals of H.R. 1089, the Mutual Fund Tax
Awareness Act of 1999. Taxes have a significant effect on mutual fund
performance, and the Commission and its staff are already working hard
to improve the disclosure that funds make to investors in this area.
The Commission remains concerned about H.R. 887. The Commission looks
forward to working with the Subcommittee on these important issues.
______
OMB Watch
November 2, 1999
Representative Michael Oxley
Chair, Finance and Hazardous Materials Subcommittee
House Commerce Committee
2125 Rayburn House Office Building
Washington, DC 20515
Representative Oxley: We are writing to ask that our statement be
entered into the record of the recent hearing on H.R. 887.
We strongly support the ideal of disclosure, and feel it is vital
to a democratic society. A large part of our mission involves working
for greater openness in government. While we realize that there can be
some downsides to full disclosure, we feel that the benefits far
outweigh any of these. Therefore, we view H.R. 887 as a positive start
for greater disclosure of corporate philanthropy, although
clarification is needed on several points.
First, will the two disclosure requirements apply only to cash
contributions made to nonprofits, or will they also include in-kind
contributions? Many publicly held companies donate products that they
manufacture, or services that they provide, to nonprofits. Also, many
companies donate office equipment to nonprofits after making upgrades.
It is important that these donations are also covered.
Second, clarification of the disclosure process in Section 2 is
required. Currently there is no indication of what the process will
involve, as the legislation simply states that the disclosure statement
must be made ``in a format designated by the [Securities and Exchange]
Commission.'' We would strongly recommend that the data be widely
available to the public using the internet. Also, allowing publicly
held companies to submit the disclosure information electronically
would ease any burden caused by the new requirements, as well as allow
easy posting on the internet.
Even though clarifications are still needed, we feel that this is
an important piece of legislation because it obliquely serves to codify
the practice of corporate philanthropy. As Representative Cox pointed
out at the hearing, by regulating disclosure of donations by publicly
held companies, this law indirectly states that corporate philanthropy
is allowed under SEC regulations.
Sincerely,
Gary D. Bass
Executive Director
Increasing Corporate Accountability?
omb watch analysis of h.r. 887
(7/06/99)
Summary
A bill introduced by Representative Paul Gillmor (R-OH) would
require stock-issuing corporations that are registered with the
Securities Exchange Commission (SEC) to disclose the amount of money
they have given to charities each year, as well as the names of
recipients of large grants, through two processes. The first would
require the disclosure of any contribution over a limit to be set by
the SEC to any nonprofit of which ``a director, officer, or controlling
person'' of the corporation ``or a spouse thereof was a director or
trustee'' to be included in the annual proxy statement. This would
include the name on the nonprofit, and the amount of the contribution.
The second process requires all corporations to annually ``make
available'' the ``total value of contributions made by the issuer to
nonprofit organizations during its previous fiscal year.'' This process
would also require the name of the nonprofit organization receiving the
donation to be included in the report, as well as the amount
contributed, if the contribution is over an amount set by the SEC.
Background
Gillmor proposed a similar piece of legislation in the 105th
Congress (H.R. 944). That bill simply called for ``disclosure of the
issuer's charitable contributions during the preceding fiscal year,
including the identity of and the amount provided to each recipient.''
The legislation was not as comprehensive as this year's bill, H.R. 887,
as it allowed the SEC to grant several types of exemptions. It was also
partnered with another bill (H.R. 945) that would have required the
approval of shareholders for any charitable contributions. Taken
together, these bills would have created substantial barriers to
corporate giving, and would have made contributions far less attractive
to companies.
Gillmor asked the SEC to evaluate the feasibility of requiring
disclosure to shareholders in the spring of 1997, and the SEC finally
released a report early this June. While the report covers general
principles of disclosure, it focuses on H.R. 887. The report finds that
the ``corporate charitable disclosure requirements in H.R. 887 would be
feasible in that companies are capable of tracking and disclosing this
information to investors.'' The report notes that many companies
already track charitable contributions for tax purposes, and some
already voluntarily disclose their contributions to the public. Gillmor
also asked that the SEC perform a cost and benefit analysis, but this
was not included in the report.
Analysis
OMB Watch supports the ideals of accountability and disclosure in
the nonprofit sector. This bill is a good beginning for greater
disclosure. Unlike foundations, public corporations are not now
required to disclose information about their contributions or grants.
Principles have been in place for some time regarding disclosure of
philanthropic endeavors. The Council on Foundations, for example
encourages its members to disclose information about contributions in
annual reports. It should not be difficult for a corporation to print a
listing of contributions in its annual proxy statement. Further, the
SEC should allow for electronic submission of the disclosure
information for ease of submission, and post it on the internet for
simple public access.
Disclosure of charitable contributions by corporations should not
be a controversial issue, nor is it costly to implement. If the intent
of the bill is to increase corporate accountability, it is interesting
that it only applies to corporate contributions. Why not include
information disclosing lobbying expenditures, campaign contributions
(both ``hard'' and ``soft'' money), expenditures for legislative,
ballot and regulatory issue campaigns, as well as other information in
annual reports? Disclosure of contributions to charities is a good
start, but is only a small part of corporate accountability.
Another important piece of the legislation is a provision that
requires the disclosure of any contributions over a limit to be
determined by the SEC made by a company to any nonprofit organization
``of which a director, officer, or controlling person'' of the company,
or the person's spouse is a ``director or trustee.'' This provision
would allow the public to see contributions that may be made simply
because of an executive's involvement with an organization. For
example, under this bill a corporation which makes a contribution
simply as a ``fee'' for an executive's seat on a nonprofit board may be
required to disclose this contribution if it is above the SEC
designated amount.
Potential Problems:
As drafted, this legislation does not apply to corporate
foundations. This could impede full disclosure, because a company
seeking to avoid disclosure could simply make a large payment to its
foundation, and then have the foundation make contributions. The
company would only be obligated to disclose its contributions to its
foundation (assuming that the contribution exceeds the threshold that
is to be determined by the SEC). There will be some level of
disclosure, however, because private foundations are required to
disclose contributions in their IRS form 990-PF. While these documents
are available for public inspection, they are most likely not delivered
to shareholders on a yearly basis, as an annual report is.
Another problem with this legislation is that contributions to
charities where an executive is a director or trustee are only
disclosed to shareholders, and not necessarily the general public. This
disclosure is to be included with the written information distributed
to shareholders before the corporation's annual meeting, which usually
is an annual report. While most corporations will give a copy of their
annual report to non-shareholders, they are under no obligation to do
so. The general public should have access to a corporation's total
charitable contributions as well as the names of charities receiving
contributions over the threshold that is to be set by the SEC,
preferably in an easily accessed electronic format. The legislation
does state that this information must be made available ``in a format
designated by the Commission,'' but does not state who this information
is to be made available to, nor does it give any hint as to the format.
It is unclear if this legislation applies to contributions made by
U.S. companies to foreign nonprofit organizations. Donations made by
U.S. corporations to foreign nonprofits may not be disclosed, as they
are not tax-deductible, and may not fall under a final definition of
``contribution.'' The legislation also appears to apply to
contributions to U.S. charities made by foreign companies that are
``registered'' with the SEC. These foreign companies may be subject to
domestic laws that may conflict with the purposes of this bill, and
there may be difficulty enforcing this legislation in foreign
companies.
Conclusion
While disclosure of corporate charitable contributions is the right
thing to do, is unlikely to have a major impact on corporate
accountability. Legislation is still needed requiring corporations to
disclose other types of contributions, such as ``soft money'' campaign
contributions. Further, because the reporting threshold has not yet
been set by the SEC, the impact of H.R. 887 cannot be fully measured.
______
Prepared Statement of Hon. John D. Dingell, a Representative in
Congress from the State of Michigan
The Subcommittee on Finance and Hazardous Materials held a hearing
on H.R. 887, legislation to mandate the disclosure of certain corporate
charitable contributions, and H.R. 1089, the Mutual Fund Tax Awareness
Act of 1999, on Friday, October 29, 1999, when the House was not in
session and only three Subcommittee Members (Reps. Gillmor, Markey, and
Cox) were able to attend.
The hearing was chaired by Rep. Gillmor, the lead sponsor of both
bills. Rep. Gillmor announced that the hearing record would be held
open to allow other Members to insert their statements. I appreciate
that courtesy and will avail myself of the opportunity to clarify the
record.
First, I note that both bills amend the federal securities laws to
mandate that the Securities and Exchange Commission (SEC) require
certain disclosures. Yet, in a departure from usual subcommittee
practice, the SEC was not invited to testify on the legislation. I have
subsequently learned that the Majority did ask the SEC to submit a
written statement but that statement was not made available to Members
either before or during the hearing. It appears that the SEC statement
raises concerns with at least one of the bills. I am submitting the SEC
statement for inclusion in the record and circulating it to Democratic
Members.
Similarly, in May 1997, six Members of the Subcommittee wrote to
the SEC asking for a report on predecessor legislation to H.R. 887. The
SEC staff report was not distributed to Members with the briefing
materials for this hearing or included in the hearing record. The
briefing memorandum mentions the SEC staff report's finding that
``imposing the corporate charitable contributions disclosure
requirements in H.R. 887 would be feasible in that public companies are
capable of tracking and disclosing this information to investors.''
However, it does not mention any of the concerns and problems that also
were discussed. Therefore, I am submitting copies of the May 1997
letter and the May 1999 SEC staff report for inclusion in the hearing
record as well.
No mention of a markup date was made at Friday's hearing. At 5:30
p.m., after most offices were closed for the weekend, the Majority sent
out a notice that both bills would be scheduled for Subcommittee markup
on Tuesday, November 2, 1999. The SEC was not notified of the markup.
No meeting has been scheduled in advance of the markup with the SEC to
discuss and address their concerns.
With respect to the substance, H.R. 1089 would require the SEC to
revise its regulations to improve the methods of disclosing to
investors in mutual fund prospectuses and annual reports the after-tax
effects of portfolio turnover on mutual fund returns. SEC staff
currently is preparing a recommendation to the Commission that the
agency issue proposed rule amendments, under its existing statutory
authority, with the intention of improving the disclosure of the tax
consequences of mutual fund investments. This issue is complex, as was
noted by the witnesses. Every investor's tax situation differs and,
short of person-by-person disclosure, it will be difficult to craft
meaningful disclosures. Any disclosure in this area will have to be
accompanied by clear cautionary narrative informing investors of the
appropriate use and inherent limitations of any new tax information.
This legislation is not necessary, but may provide a beneficial prod,
as long as the SEC is given sufficient flexibility in implementing the
legislation's goals. The SEC has submitted a package of technical
changes to H.R. 1089. These should be taken care of.
H.R. 887 requires all SEC-registered companies to annually make
available, in a format to be designated by the SEC, the total value of
contributions made by the issuer to nonprofit organizations during the
previous fiscal year. The name of the organization receiving the
donation and the amount contributed also must be included in the report
for any contributions over a threshold amount to be set by the SEC.
H.R. 887 also requires SEC-registered companies to disclose in their
proxy statements any contributions, over threshold to be set by the
SEC, made by the issuer during the previous year to any nonprofit
organization of which a director, officer, or controlling person of the
issuer, or spouse thereof, was a director or trustee, including the
name of the organization and the value of the contribution.
Concern has been raised that this disclosure could be used in
furtherance of improper political or personal agendas. Moreover, if the
intent of the bill is to increase corporate accountability, it is
curious that it only applies to corporate charitable contributions.
Disclosure of contributions to charities is only a small part of
corporate accountability. Why not include information disclosing
lobbying expenditures, campaign contributions (both ``hard'' and
``soft'' money), expenditures for legislative, ballot, and regulatory
issue campaigns, as well as other significant information?
In addition, the SEC staff report on H.R. 887 raises the following
specific concerns:
(1) There does not appear to be evidence of widespread (or even
significant) abuse--only a handful of examples or allegations
have been provided.
(2) Information regarding charitable giving by corporations is
currently available:
Some companies voluntarily make available information
regarding their charitable contributions to shareholders.
Corporate private foundations are required, under IRS
regulations, to make a list of contributions available to
the public, and apparently the IRS is amending its
regulations to improve public access.
(3) There does not appear to be evidence of widespread shareholder
interest in obtaining this information:
Companies that make such information available to
shareholders have found relatively low shareholder
interest.
Only a small number of shareholder proposals for
disclosure of charitable contributions have been offered
and voted upon, and none have been approved by
shareholders.
(4) The information may not be material to investors since it may not
be considered relevant to a reasonable person's investment
decision, particularly if the donations are not improper:
Corporations donate an average of a mere one percent of
their pretax income to charity.
The SEC generally requires disclosure of information that
is is ``material'' so that disclosure is meaningful and
does not overwhelmshareholders. Only in very rare
instances, if at all, would corporate charitable
contributions meet any reasonable ``materiality'' standard.
(5) Companies may evade the disclosure required by the bill:
By making contributions through their foundations;
By making contributions below any threshold; and
By characterizing payments as business expenses instead of
charitable contributions.
(6) The costs of compiling the information may not be as low as
proponents anticipate because companies may not have
centralized records of all types of contributions including
cash, products, services, use of facilities and time of
employees.
I intend to vote against H.R. 887 in its current form.
[GRAPHIC] [TIFF OMITTED] T1039.005
[GRAPHIC] [TIFF OMITTED] T1039.006
[GRAPHIC] [TIFF OMITTED] T1039.007
[GRAPHIC] [TIFF OMITTED] T1039.008
[GRAPHIC] [TIFF OMITTED] T1039.009
[GRAPHIC] [TIFF OMITTED] T1039.010
[GRAPHIC] [TIFF OMITTED] T1039.011
[GRAPHIC] [TIFF OMITTED] T1039.012
[GRAPHIC] [TIFF OMITTED] T1039.013
[GRAPHIC] [TIFF OMITTED] T1039.014
[GRAPHIC] [TIFF OMITTED] T1039.015
[GRAPHIC] [TIFF OMITTED] T1039.016
[GRAPHIC] [TIFF OMITTED] T1039.017
[GRAPHIC] [TIFF OMITTED] T1039.018
[GRAPHIC] [TIFF OMITTED] T1039.019
[GRAPHIC] [TIFF OMITTED] T1039.020
[GRAPHIC] [TIFF OMITTED] T1039.021
[GRAPHIC] [TIFF OMITTED] T1039.022
[GRAPHIC] [TIFF OMITTED] T1039.023
[GRAPHIC] [TIFF OMITTED] T1039.024
[GRAPHIC] [TIFF OMITTED] T1039.025
[GRAPHIC] [TIFF OMITTED] T1039.026
[GRAPHIC] [TIFF OMITTED] T1039.027
[GRAPHIC] [TIFF OMITTED] T1039.028
[GRAPHIC] [TIFF OMITTED] T1039.029
[GRAPHIC] [TIFF OMITTED] T1039.030
[GRAPHIC] [TIFF OMITTED] T1039.031
[GRAPHIC] [TIFF OMITTED] T1039.032
[GRAPHIC] [TIFF OMITTED] T1039.033
[GRAPHIC] [TIFF OMITTED] T1039.034
[GRAPHIC] [TIFF OMITTED] T1039.035
[GRAPHIC] [TIFF OMITTED] T1039.036
[GRAPHIC] [TIFF OMITTED] T1039.037
[GRAPHIC] [TIFF OMITTED] T1039.038
[GRAPHIC] [TIFF OMITTED] T1039.039
[GRAPHIC] [TIFF OMITTED] T1039.040
[GRAPHIC] [TIFF OMITTED] T1039.041
[GRAPHIC] [TIFF OMITTED] T1039.042
[GRAPHIC] [TIFF OMITTED] T1039.043
[GRAPHIC] [TIFF OMITTED] T1039.044
[GRAPHIC] [TIFF OMITTED] T1039.045
[GRAPHIC] [TIFF OMITTED] T1039.046
[GRAPHIC] [TIFF OMITTED] T1039.047
[GRAPHIC] [TIFF OMITTED] T1039.048
[GRAPHIC] [TIFF OMITTED] T1039.049
[GRAPHIC] [TIFF OMITTED] T1039.050
[GRAPHIC] [TIFF OMITTED] T1039.051
[GRAPHIC] [TIFF OMITTED] T1039.052
[GRAPHIC] [TIFF OMITTED] T1039.053
[GRAPHIC] [TIFF OMITTED] T1039.054
[GRAPHIC] [TIFF OMITTED] T1039.055
[GRAPHIC] [TIFF OMITTED] T1039.056
[GRAPHIC] [TIFF OMITTED] T1039.057
[GRAPHIC] [TIFF OMITTED] T1039.058
[GRAPHIC] [TIFF OMITTED] T1039.059
[GRAPHIC] [TIFF OMITTED] T1039.060